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GIRDLER'S lecturer in economics at the university of CAMBRIDGE 





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First Published in ig2i 


AT the risk of being charged with an attempt to rob 
criticism of its rightful bread, I feel bound to meet in 
advance an objection which may be made to the general 
character of this book : the objection, namely, that the 
convulsive changes of the last six years have so greatly affected 
the work of the Money Market that they have fundamentally 
altered the nature of the services it contributes in the economic 
organization of this country. 

Yet, when an engine is out of order, the skilled mechanics 
who are called in to examine and repair it bring with them no 
new ad hoc set of mechanical principles ; and the fair-minded patient, 
though his state of mind argues a world in revolution, recognizes 
that the principles of physiology have not ceased to operate. The 
tale runs that an eminent divine, after a decisive defeat of his 
party in the House of Commons, returned home and planted 
mustard and cress in his garden. Not long after he was able to 
assure his friends that, crushing as had been their political defeat, 
the herbs had nevertheless come up in much the usual way. It 
may be that they would grow now in the garden of the Bank of 
England, or even in a land reshaped to the lives of heroes. 

It is true that the war has loosened ideas, has released influences 
hitherto held in check by a sense of the inherent unalterableness 
of things, and by so doing has modified our general conceptions 
of the true relations among members of a modern society : in 
paxticular the relations between rich and poor, and between master 
and man. But the economic centre of the social organization 
has surely not greatly changed. Much the same impulses and 
much the same needs govern the adjustment of economic resources 
to economic ends; the long chains of processes through which 
materials pass on their way from the soil to the consumer are much 
the same as they were, though their operation is disturbed by an 
additional set of difficulties introduced by the war. 


This seems to be especially true in those inner and strictly 
business processes with which the Money Market is concerned. 
The banks still supply the means of effecting payments in the form 
of a cheque currency of unrivalled efficiency ; they and the Issue 
Houses still collect capital from points of plenty and carry it to 
points of scarcity ; the company promoter, in the old extravagant 
way, still supplies business ability with the resources required to 
give it scope ; severe alternations of economic activity and stagna- 
tion still arise from infectious changes of confidence on the part of 
the business men to whom society still entrusts the administration 
of its resources. Broadly speaking, the same principles of action 
lead to the same social economies and the same social wastes, though 
they work themselves out with less sureness and precision in face 
of the greater uncertainty which in present conditions affects all 
business adjustments. 

If this book aimed at a descriptive account of the detailed 
phenomena of the Money Market, it would necessarily be concerned 
mainly with the manner in which the market was adjusting its 
operations to the special disturbances arising from the war, and 
would deal principally with such matters as the abolition of time 
dealings on the Stock Exchanges, the influence of public finance 
on monetary conditions and the prospects of a return to an effective 
gold standard. But that is not its object. Its main purpose is 
one not of description but of interpretation. It attempts to trace 
the nature of the economies which the market effects as part of 
the organization of production, and to express those economies in 
terms of economic welfare. That being its object, it is concerned 
less with the special difficulties arising during the present period 
of transition than with those more general and fundamental con- 
ditions which are common to the present time, the past, and, it 
may reasonably be expected, the future. 

F. L. 

Emmanuel College, Cambridge _ , 





I. Introductory ....... i 

II. The Market in relation to Money and Capital . 6 

III. The Market in relation to Credit . . .14 

IV. General View of the Market . . . - 19 

V. The Quantity Theory .... 
VI. The Demand for Money ..... 
VII. The Supply of Money— Its Technical Efficiency 
VIII. Do. —Its Stability of Value 

IX. Do. —Social Disturbances due to 

Instability of Value 

X. Summary ...... 





XI. The Flow of Resources into Investment . . 65 

XII. The Influence of the Market on the Supply of 

Capital— Waiting . . . . -73 



XIII. The Influence of the Market on the Supply 

OF Capital— Risk . . 82 

XIV. Do. —Risk arising from Imperfect 

Knowledge . . . .85 

XV. Do. —Risk arising from the Immo- 

bility OP Invested Resources 91 

XVI. Do. — Marketing . . . .98 

XVII. The Influence of the Market on the Demand 

for Capital ...... 102 

XVIII. Review of Marketing Operations . . .112 



XIX. The Banking System— Preliminary . . .125 

XX. Do. —The Transport of Capital; 

its Collection and Pooling 134 

XXI. Do. —The Transport of Capital; 

ITS Distribution . . 140 

XXII. Do. —The Provision of the Cheque 

Currency . . .147 

XXIII. Do. -—The Volume of the Currency 150 

XXIV. Do. —The Elasticity of Supply . 154 

XXV. Do. —The Machinery of Regulation 161 

XXVI. Do. —The Regulation of the 

Currency . . .165 

XXVII. Do. —Conclusions . . .177 

, XXVIII. The Market for Stock Exchange Securities— New 

Securities . . . . . .183 

XXIX. New Securities {continued)— The Characteristics of 

THE Market . . . . . . i8c 



XXX. New Securities {continued}— The Sale of High-Class 

Securities . . 193 

XXXI. Do. —The Volume of Indus- 

trial Securities . 200 

XXXII. Do. —The Sale of Indus- 

trials . . . 207 

XXXIII. Do. Do. {continued) 213 

XXXIV. The Market for Old Securities . . .220 
XXXV. The London Stock Exchange . . . .223 

XXXVI. Do. {continued) . . 228 

XXXVII. Speculation on the London Stock Exchange . 232 

XXXVIII. The Direct Product of the Speculator . . 235 

XXXIX. The Speculator's Profit . . . .240 

XL. Do. {continued) . . , 245 

XLI. The Influence of the Speculator on Prices . 250 

XLII. Other Incidental Effects, and Conclusion . 257 

XLI II. Trade Credit . . . . . . 263- 

XLIV. Conclusion . . . . . . .274 

NOTES 283 

INDEX 295 





MODERN industrial communities may have much to 
leam from older civilizations with regard to the art of 
living ; but they have at least this great quaUty, that 
they are unsurpassed in industrial efficiency. There is 
nothing in the past to parallel a productivity like that of England, 
where an inconsiderable island is made to yield annually products 
valued in 1914 at more than £2000 m., and to support a popula- 
tion of over 40 milHons of people. 

The great growth in the industrial power of modem communities 
has been accompanied by a change in their social structure, or 
more exactly by a much higher development of characteristics 
which have always been present. The great branches of produc- 
tion have grown more distinct ; the trades within them have moved 
apart and become more clearly defined, and the complex operation 
undertaken by each trade has, as it were, been taken to pieces and 
separated into its elementary processes. 

The incentive to this change arises from the great productive 
efficiency which accompanies specialization ; for this separation 
of processes makes it possible to employ each human and mechanical 
agent uninterruptedly on a narrow range of work of a kind adapted 
to its highest productive capacity. 

The term " Division of Labour " describes this general tendency 
of specialization in so far as it affects one of the agents of production 
— human beings ; but it does not bring out clearly the fact that the 
tendency affects also the other agents — capital and land. WTien 
an operation is broken up into separate processes, it is evidently an 
economy of the first importance to group these simpler processes 
together and to engage continuously on each the class of work- 


people (or managers) whose abilities and training are specially 
adapted to the purpose. But what is true of Labour is true also of 
Capital and Land. It is economical in exactly the same way to 
apply to each process its appropriate specialized machinery and to 
allocate each group of processes to the site which offers the greatest 
natural advantages, whether of soil, of climate or of position. The 
more general statement of this tendency is, therefore, that the 
growth of industrial power is associated with an increased ability 
to break up industrial operations into their elementary parts, to 
group together the similar parts and to redistribute these groups in 
such a way as to concentrate upon each the human skill, mechani- 
cal arrangements and natural advantages most suitable for their 

But the ability to break up and separate the parts of an opera- 
tion in this way is itself dependent upon another condition ; such 
subdivision can obviously be carried out only if there is a corre- 
sponding development of communications, by means of which the 
dissociated parts are co-ordinated and inter-connected. The 
system of communications falls naturally into three parts : the 
transport of intellig(jnce, of material things and of value. Their 
effects may be briefly considered in that order. 

It is evident that the separation of cotton marketing from cotton 
manufacture and its concentration in Liverpool and Manchester 
has been greatly facilitated by the development of the telephone, 
the telegraph and the postal system. Similarly, if a factory opera- 
tion hitherto carried out by one man is to be subdivided between 
two, this can be done only by introducing some co-ordinating 
mechanism such as a foreman, who takes over a part of the mental 
processes and acts, as it were, as a bridge regulating and co-ordinating 
the operations of the two workpeople. 

In the same way, the development of means for transporting 
material goods is a most important condition in the separation of 
processes. Just as the mechanical carrier in the large shop facili- 
tates a more complete separation between the selling and account- 
ing branches of the business ; so the railway and the steamship 
release factories from the sources of their raw materials and enable 
them to settle on distant sites more suited to their particular opera- 
tions. It was the growth of railways which liberated cotton- 
growing in India from the outskirts of each village and enabled it 
to move to more remote areas of greater natural advantages. 

Finally, this ability to concentrate each producing agent on a 
narrow range of services is dependent on the growth of the system 
by which value, or general purchasing power, is readily transferred 
from one person to another. It is dependent on the provision of 
means and facilities for making payments, i.e. on the provision of 


means for effecting payments in general and on the provision 
of facilities for effecting those particular payments by which 
capital is transferred from the control of one party to another. 

It is evidently possible for individual producers to concentrate 
their energies on the output of a single kind of service or product 
only in so far as means are provided by which these products may be 
quickly and conveniently exchanged by way of piu^chase and 
sale ; their specialization is limited by the efficiency of the money 
system — by the ease and safety with which the community can 
make the payments by means of which these products are redistri- 
buted ; and each improvement in the form of the currency enables 
this specialization to be carried out more completely than before. 
The development of the cheque currency in England marks a great 
increase in the efficiency of this kind of communication. A return 
even to a sound gold coinage would be equivalent to a heavy tax 
on all distant dealings ; for the purchase of goods from a distance 
would involve the expenses and risks of sending coin in payment. 
In such conditions, therefore, many of these purchases would no 
longer be made, and production would be concentrated to a less 
extent at the most suitable sites ; in other words specialization 
would be checked, and productive capacity would be appreciably 

The development of a speciaUzed class of entrepreneurs under- 
taking the management of business is dependent in a similar way 
on the transport of capital ; it is facilitated by every increase in the 
efficiency of the machinery by which purchasing power devoted to 
capital uses is carried into the hands of business men. In the 
absence of the banks and other machinery for the transport of 
capital, business undertakings would be formed only when the 
ownership of capital and business abiUty happened to coincide ; 
but with the development of this machinery for joining together 
capital and business ability each can be separately produced ; the 
resources of the capitaUsts who have no aptitude for business 
management are joined to the ability of the entrepreneurs who lack 
capital ; consequently the supply of each of the two agents becomes 
increasingly speciaUzed with great advantage to the productive 
capacity of society. Just as the cost of production of a factory is 
reduced by the development of railways, steamships and similar 
transport faciUties which enable its constituent parts to be produced 
at the most efficient sources, so the cost of production of a business 
undertaking is lessened by the work of the Money Market in trans- 
porting capital and thereby giving scope for the separate supply 
of the two elements, capital and business power, of which the under- 
taking is composed. Striking evidence of the organic changes 
i introduced by the development of the Money Market is seen in the 


growing separation of the investor and the entrepren'jur which 
accompanies the rapid increase in public joint-stock companies. 

The machinery for the transport of value consists therefore of 
two distinct parts ; each of these parts is concerned ultimately 
with facilitating payments; each exercises an influence on the 
specialization of productive resources analogous to that of the 
railway and the 'telegraph. The influence of the first part depends 
on the efficiency of the money system, that is to say, on the ease 
and safety with which payments in general can be effected. The 
influence of the second part depends on the efficiency of the 
machinery for transporting capital, that is to say, on the economy 
with which money available for capital uses is carried from those 
in whose hands it accumulates to those by whom it is applied to 
its various uses. 

There is then this triple system of communications dealing with 
intelligence, material things and value. Every improvement in this 
system not only introduces its own immediate economies but 
operates as a solvent, enabling processes naturally allied to be 
separated and regrouped in such a way that more highly specialized 
agents of production may be brought to bear on them and a further 
set of economies realized. And this specialization in its turn 
reacts on the efficiency of the means of communication. 

These economies stated in an abstract form do not greatly 
impress the mind, and it is adding Httle to point out that they 
form the main basis of the economic argument for Free Trade. In 
the concrete they are perhaps most clearly seen in the conditions 
of large towns. Evidently the essential economic circumstance 
of a large town is simply the physical proximity of the people 
congregated there. This proximity implies an enormous economy 
in the cost of communications ; speech is substituted for the written 
letter ; material goods need to be carried much shorter distances ; 
exchanges are facilitated and the risks of loans are greatly reduced. 
These economies in communications mean large accessible markets ; 
and large markets, in their turn, lead directly to more highly 
specialized forms of production and yet further economies. These 
twofold economies are reflected in the huge site rents of densely 
populated areas, and indeed, if allowance is made for non-economic 
considerations and for such purely physical site advantages as 
climate and water power, are measured by those site rents. 

The Hues of this argument are old and familiar. They are 
restated with the view of bringing out as clearly as possible the 
fact that more efi&cient means of communication have results 
beyond the direct economies which they introduce ; for, over 
and above these immediate economies, they enable society 
attain greater productive efficiency by breaking its work in 


more elementary parts, regrouping these parts and applying to 
each group a more highly speciaUzed form of the services of human 
beings, mechanical appliances and land. 

This book is concerned only with that part of this system of 
communications which has been distinguished as the transport 
of value, a part which may be roughly identified with what is 
known as the Money Market. Its object is to bring out the social 
significance of the market as a coherent part of the organization 
by which resources are adjusted to needs : to connect market 
phenomena with economic welfare. The market, Uke the telegraph 
and the railway, forms part of the general means of communica- 
tion ; accordingly every increase in its efficiency encourages an 
organic development of society and gives scope for a higher pro- 
ductive capacity. These effects must be noticed if the significance 
of its work is to be suggested. It is, however, impossible to do 
more than notice them. The influences operating in the market 
are very complex, and its consideration as an organic thing, i.e. 
as a part of a living and developing industrial system, is quite 
beyond the scope of this book. Even as a dynamic thing its 
consideration must be very incomplete, for in its continuous 
process of readjustment to disturbing influences the organization 
sets up movements whose final consequences it is hardly possible to 
trace and express in any simple way until the machinery of 
economic analysis has been greatly improved. If, therefore, the 
argument is to be inteUigible, it can do no more than touch on organic 
changes and consider dynamic movements when their effects are 
important and easily traced; it must in the main be confined 
to a problem rather static than dynamic in character ; it must 
attempt to express the social economies which arise from the 
more important permanent forces entering into the composition 
of the market, those forces being regarded as in that equihbrium 
which they would attain if time were given them to work out 
their full effects without interruption. 


THE object of the preceding chapter was to place the 
organization with which this book is concerned in its 
general relations with the industrial system and to in- 
dicate the indirect economies to which it gives rise by 
its influence on the organic growth of the system. We have now 
to come to closer quarters with the subject in order to show what 
agencies and institutions are included in this organization ; to 
express more definitely the nature of those direct economies which 
it produces, and with which alone we are henceforward concerned ; 
and, finally, to establish leading ideas in the light of which these 
economies are to be examined. 

^ This organization has already been roughly identified with 
the Money Market. It consists of a nucleus of specialized institu- 
tions, such as the banks, the market for negotiable securities, 
the bill brokers and the trust and finance companies, which form 
the inner market, or Money Market proper. ^ But it extends 
beyond this centre forming an outer market which includes the 
work of the solicitor who arranges for the transfer of capital on 
mortgage, of the provincial broker who promotes the sale of new 
and old securities, of building societies which facilitate invest- 
ment in houses, of the system of trade credit and of those less 
definite arrangements for facilitating the movement of capital 
which, as the market is extended outwards, become more and more 
closely bound up with the ordinary processes of trade and industry. 
The organization cannot, however, be accurately described by 
mere enumeration ; it must be defined in terms of its typical 
services, and must be taken to be co-extensive with all the opera- 
tions by means of which these services are performed. 

What, then, are the essential services of the organization ? 
In what way does it enable social resources to be adjusted more 
effectively to meet social needs ? What is tl?e nature of the social 
economy which it effects ? 

The answer to this question is a simple one. All the complex 
and highly specialized processes which form the organization of 
the market are tributary to two functions : they are an elabora- 
tion of two elementary services : the first is that of supplying a 


stock of money ; the second is that of facihtating the transport of 

The EngUsh banks perform both services simultaneously : 
Issue houses, floating loans, transfer capital from the control of the 
public to that of the borrower ; Accepting houses do similar work 
by guaranteeing the payment of bills and so reducing the risks of 
those who supply capital against this form of security ; foreign ex- 
change departments of banks provide means of payment between 
one country and another ; the working of the Bank rate contributes 
to the making of payments by regulating the volume of the 
currency ; the real meaning of every market operation is to be 
found in its effects in facilitating the making of payments, the 
transfer of capital, or in both together. 

The market is defined in terms of these two services : every 
process devised to perform these services forms part of the market ; 
conversely, the market includes only those processes by which 
these services are performed. 

Although these two services are fundamentally different in 
nature, they are closely bound up together in practice, and are in 
consequence frequently confused with one another. If the subse- 
quent argument of this book is to be intelligible it is essential that 
they should be distinguished as clearly as possible. It will be 
as well, therefore, to consider briefly the conditions in which the 
demand for these services arises and the nature of each. We may 
do so most conveniently by considering the case of a single individual, 
whom we take to be broadly representative of society as a whole. 

In simple conditions where each individual devoted his energies 
directly and solely to the satisfaction of his own needs, the products 
that he required for his existence would emerge directly from his 
efforts into his own possession and he would experience no need 
for the means of acquiring products by way of exchange from 
other people ; he would have no need for money. Further, as he 
would himself employ for his own purposes any implements and 
stores of raw material in his possession, he would not desire to lend 
them to other people, and he would consequently need no assist- 
ance in lending them with ease and security ; he would have no 
need for any agency which facilitated the transport of capital. 
The need for the use of money and for facilities in transporting 
capital arises when people become interdependent ; when means 
of communication become necessary in order to give scope to the ■ 
growth of specialization. 

In modem conditions this interdependence is very highly 
developed. In the typical case, each individual confines himself 
to the supply of some specialized service, and these separate services 
are co-ordinated into a stream of services which gives rise to the 


flow of products constituting the National Output. There follows 
an elaborate process of exchange, and this National Output re- 
appears as the National Income or Dividend, the whole of it being 
divided among the parties producing it in proportion to the market 
value of the service supplied by each. Each party to production 
then, whether capitaUst (or landlord), business manager, or labourer, 
obtains a title to a fraction of the total output, a title whose size 
is measured by the market value of the service which he contributes. 
This title represents a control over social resources and constitutes 
his real income. From these conditions there arise a demand for 
money and for faciUties in transporting capital. 

In these circumstances, in contrast with the simple conditions 
previously considered, each individual finds himself in possession, 
not of the various products he needs for his existence, but of a 
claim to a share in the general flow of products emerging in the 
hands of private owners. The value of his service gives him a 
right to a fraction of this flow, but not the means by which this 
right can readily be exercised. He needs some convenient means 
of administering his resources ; some means of transferring portions 
of his property to other parties by way of payment for the various 
products he needs to acquire from them, by way of dues to the 
State, or by way of loan. He needs therefore to convert his title 
into some intermediate product which, being readily marketable, 
divisible, transferable and so on, serves as general purchasing 
power, and so may conveniently be employed as a means of pay- 
ment. Many commodities possess these properties in greater or 
less degree ; but the highest efficiency is attained when this inter- 
mediate product is produced in the specialized form of morifiy, 
adapted by its supreme quality of general acceptability, and by 
its minor technical qualities, to be readily transferred fropi hand 
to hand as a means of payment. 

While, in simple conditions, we have then an outflow of services 
and an inflow of products, in modem conditions we have an outflow 
of services exchanged into an inflow of money and an outflow of 
money re-exchanged into an inflow of products. It is with these 
inner streams of money, the intermediate mechanism, that we are 
now concerned. At their point of junction they will widen out 
into a pool ; for the payments which each individual needs to make 
are irregular and uncertain, and he will consequently need to 
accumulate a part of his income and hold it in the form of a stock 
of money. The size of this stock, like that of his stock of other 
instruments, will depend on the amount of work to be done ; it 
will depend primarily upon the volume and uncertainty of the 
payments he requires to make. Each individual, then, will 
forego part of the products he can command and invest a 


fraction of his real income in the form of a stock of money 
as a means of conveniently administering the resources which he 
controls. The amount of wealth which he holds in this particular 
form constitutes his individual demand for money ; the sum of 
these individual demands constitutes the total demand for money. 

But there is a peculiarity in the relation between the total 
demand for money and the total supply which may be noticed 
even at this early stage, for its discussion brings out more clearly 
the nature of money and the manner in which it does its work. 
The total demand for money has been taken to be the sum of the 
quantities of goods which people forego in order to acquire their 
money stocks. This aggregate quantity of goods, then, purchases 
the total stock of money, the stock of counters in which all values 
are expressed ; and this stock of counters does the money work of 
the community. Now, within wide limits, it is a matter of in- 
difference to the community whether the denomination of the stock 
of counters so purchased is high or low, and whether the number 
of these counters is large or small. If the denomination of each 
counter is high, the value of the goods by which these counters 
were purchased is expressed in large figures ; if the denomination 
is low, the value of these goods is expressed in small figures ; the 
stock of counters does the same work in each case, but does it in 
different terms, that is to say, at a different level of prices. Exactly 
the same argument appUes with regard to the number of counters 
comprising the total stock. If the total quantity of goods con- 
stituting Demand purchases a large number of counters, each 
item of goods exchanges for many counters, prices are high and 
each payment requires the use of many pieces of money. If, on 
the other hand, it purchases few counters, prices are low and each 
payment is carried through with the use of few pieces of money. 
More concretely, a stock of two hundred milHons of sovereigns will • 
carry through the total volume of payments at one price level, 
while a stock of one hundred milUons will carry through the same 
volume of payments equally well at a price level one-half as high. 

Owing, then, to the unique manner in which the money stock 
does its work — its operation as an intermediate stock continuously 
bought with goods and sold for goods — it differs in one important 
respect from other stocks of instruments employed by the com- 
munity. Its pecuHarity hes in this : that whether it is composed 
of many or few counters, of high or low denomination, it will do 
no more and no less than carry through the total volume of pay- 
ments. But if the economic services yielded by the total stock 
are independent of the number and size of the units of which it is 
composed, it follows that the real value of the stock of money held 
by any country depends simply on the volume of payments to be 


effected ; and that this value is measured by the quantity of goods 
which people are prepared to forego in order to effect those pay- 
ments — ^in order to obtain the means which enable them to ad- 
minister their resources conveniently. 

But while the number and denomination of the pieces composing 
the total stock of money are properties which do not appreciably 
affect the services it performs, there are two properties which 
have an important influence on these services. In the first place, 
the form in which the pieces of money are supplied is by no means 
a matter of indifference. The pieces may be printed on metal in 
the form of gold, silver, bronze and nickel coins, or on paper in the 
form of notes, postal orders and cheques ; each form possesses 
qualities which adapt it more or less perfectly to serve as a means 
of payment. If it is desirable that the community should be 
supplied with machines technically ef&cient in the production of 
goods, it is equally desirable that it should be supphed with the 
forms of money which have the highest technical efficiency as a 
means of effecting payments. The second property which money 
should possess is of greater importance still. While it is true, as 
already shown, that the value of the counter — of the unit of money — 
is of no appreciable consequence, it is also true, as will be shown 
later, that changes in the value of this unit are very important 
indeed, for during their course they cause an upward or downward 
movement of prices which is accompanied by considerable social 
disturbance. If this important property, stability of value of the 
unit of money, is to be attained, there must be a continuous adjust- 
ment of supply to changes in the volume of money work to be 

This argument is intended to bring out the nature of the first 
service of the Money Market —-that of the provision of a currency. 
The conclusion to which it leads is that the efficiency with which 
the market performs this service is to be judged by the degree of 
success which it attains in suppl3dng a currency of the highest 
technical efficiency, and in regulating the supply of this currency 
in a manner which so far as possible maintains the unit of money 
at a stable value. 

So far, the typical individual is seen as a party to production, 
who acquires a title to a fraction of the total flow of products by 
virtue of the service he contributes, and exercises this title by 
means of his stock of money. In order to distinguish the nature 
of his demand for the second service provided by the market we 
need to examine the manner in which he employs the resources at 
his disposal. 

The control which he is entitled to exercise over the productive 
capacity of the community will be employed in the satisfaction 


of wants present and future ; it will be devoted partly to purposes 
of consumption, partly to purposes of investment. In the former 
use, he directs social resources to supply him with products which 
are destroyed by current consumption ; and he does so by means of 
the stream of money payments which represents that part of his 
income which he " spends." In the latter use, he either directs 
social resources to the construction of buildings and other pro- 
ducts which yield up their satisfactions mainly in the future ; or 
he transfers to other parties, in exchange for a rate of interest, a 
control over resources which he himself does not choose to exercise ; 
and he does so by means of a stream of money payments which 
represents that part of his income which maintains, or adds to, 
his savings. 

The total real resources annually devoted by people to these 
latter uses forms the annual supply of " free capital " in the strict 
sense of that term. In simple conditions, it would seem, the form 
in which this free capital appears is that of food ; for only when a 
community is able with a part of its labour to supply food for the 
whole can it release the remainder from the need of self-mainten- 
ance, and direct it to the production of stores, buildings and, above 
all, the tools by which it may cumulatively increase its productive 
capacity. In modem conditions, it would seem, this free capital 
originates in the form of a stream of miscellaneous products drawn 
from the National Output, by means of which materials are obtained 
from abroad, and business energy, labour and plant are maintained 
during the period of production. The original stream of mis- 
cellaneous products, converted by exchange or by the productive 
energy it maintains into other forms, becomes less and less " free " 
as it is transformed by successive processes into its final shapes : 
fixed capital, claims against foreign countries, or materials such 
as munitions of war destined for immediate destruction. From 
this point of view, then, the annual stream of free capital, re- 
garded in the concrete, has no distinctive form', for it includes 
not only food and raw materials which may be turned to 
almost any use, but also highly speciaHzed products such as loco- 
motives exported to the Argentine and exchanged for wheat. It 
has, however, a distinctive quality ; for in order to be " free " 
it must be capable of conversion into buildings and plant, 
exportable goods, provision for national security and other forms, 
material and immaterial, to which the capital of the community 
is devoted. It is, perhaps, most easily conceived as the portion of 
the National Output which is not employed, by the individuals 
who control it, for purposes of current consumption ; or, more 
simply, as that fraction of the total productive capacity of a country 
which is available for such purposes as the maintenance and 


extension of its business equipment, or for meeting the emergencies 
of the State. 

As already noticed, portions of this surplus productive capacity j 
are transferred by individuals who control it to other parties who.| 
offer a price, a rate of interest, for its use. This transfer is effected ' 
by means of the stock of money, in the form of a stream of general 
purchasing power, usually known as "free," or "floating," capital. 
But what is actually transferred is clearly not capital, but Com- 
mand over Capital, and it is of some importance to emphasize the 
distinction ; for Command over Capital may be readily expanded, 
and in times of active business is expanded, without any corre- 
sponding increase in the real capital which it controls. 

In effecting this transfer, it is the object of the investor to 
convey his " capital " to those parties from whom he can obtain 
the highest net return. But to do so is a task which involves 
much trouble and skill. It requires an intimate knowledge not 
only of the business men and others who bid for the use of the 
capital, but also of the undertakings in which they are engaged ; 
and the absence of this knowledge on the part of the ordinary 
investor constitutes a gap between the sources of the Supply and ' 
Demand of capital. There arises therefore a need for the services 
of expert intermediaries, such as the banks, the Issue houses and so I 
on, who, being in touch on the one side with parties in possession i 
of disposable capital, and on the other with parties anxious to employ 1 
it, will bridge the gap between the two and facilitate the move- 
ment of capital from one to the other. The second service of the 
market lies then in facihtating the movement of this stream of money, 
of Command over Capital, whereby the control over a part of the 
productive resources of society which is available for capital uses is 
transferred into the hands of those by whom it can most effectively 
be employed. 

This, then, is the point of view from which we may regard money 
and capital. The supply of money in any community is a stock, 
essentially a stock of counters whose general acceptability enables 
them to serve as a control over resources in general and so form a 
convenient means of effecting payments. It is the business of the 
market to manufacture these counters in a convenient form, and 
to adjust their supply to the changing volume of payments so as 
to maintain the purchasing power of the unit of money as nearly as 
possible at a constant level. By so doing, it facilitates the dispatch 
of business transactions, thereby increasing the efficiency of produc- 
tion, and adding to the size of the National Dividend. On the other 
hand, the annual supply of capital in any community is a flow ; it is 
that part of the productive capacity of the community which can be 
spared during the year from the task of satisfying immediate wants 


and devoted to purposes such as the maintenance and extension 
of industrial plant and machinery. A part of this annual flow of 
free resources is applied directly by its owners ; the remainder is 
transferred into the hands of other parties, by way of loan and so on, 
through the agency of a stream of money, of control over resources, of 
Command over Capital, or, more loosely, capital. It is the business 
of the market to facilitate the movement of this stream of Command 
over Capital to the points of highest yield, just as a r^ilway-facilitates 
the movement of goods to the points of highest demand. By so 
doing, it enables a control over resources to pass into the hands of 
those who can employ them most effectively, thereby increasing 
productive capacity and swelling the National Dividend. 


THE work of the market in each of the two services which 
have just been discussed is influenced in a very important 
way by what is vaguely known as " credit." The part 
played by credit in the market organization cannot be 
considered at all fully at the present stage. Its importance lies partly 
in the economies arising from what may vaguely be described as the 
normal level of credit ; partly in the influence which changes in this 
level exercise on the activity of the market ; at one time greatly facili- 
tating its work and causing an undue expansion in its operations ; 
at another, checking its work and unduly contracting its operations ; 
in either case, causing a disturbance in the adjustment of economic 
means to ends. At the moment we are concerned only to establish 
as clearly as possible the nature of credit and of the normal economies 
to which it gives rise ; in the following chapter the matter will be 
carried a stage further and some preliminary account given of its 
effects in alternately stimulating and depressing the market. 

Jevons was so impressed by the ambiguities of the term " value " 
that he thought the expression should be ehminated from the text- 
books. He might with equal force have advocated the abolition 
of the term " credit." Credit is used in many senses and is often so 
used in the same context, with the result that a vague impression is 
often given of something being created out of nothing, and an almost 
mystical atmosphere is thrown over operations in themselves quite 
simple and concrete. If, for example, one is told that a house is 
built " on credit," it is only too easy to interpret the term credit 
as meaning at the same time both the capital employed in building 
the house and the business reputation which enabled the builder 
to borrow the capital necessary for the purpose. Unless a definite 
mental effort is made to separate these inconsistent meanings, a 
vague idea is left in the mind that, by some obscure use of credit, 
bricks and mortar have been produced from thin air, when in point 
of fact all that credit has done has been to enable capital to be 
transferred from the hands of one party, who is thereby deprived of 
its use, into the hands of another party who has employed it to 
build a house. 

It seems to be quite impossible to find any definition of the term 


which covers all the uses in which it is actually employed, but this 
is hardly to be expected in view of the inconsistent meanings which 
it receives. Essentially credit seems to be a condition which enables 
a person to extend his control, as distinct from his ownership, of re- 
sources. A short 'phrase, power to borrow,^ though not perfectly 
accurate, is more convenient in use ; thus a man's credit is high 
when his power to borrow is good ; a bank grants credit when it 
grants the power to borrow and a credit currency is a currency based 
on the power to borrow. The point to notice especially is that credit 
cannot increase the supply of resources at the disposal of the com- 
munity ; its function lies in facilitating the transfer of these 
resources from one party to another. Credit is a condition, a con- 
dition which may be expressed on the one side as the power of 
business men and others to borrow from capitalists and on the other 
as the confidence on the part of the investor in the person to whom 
he entrusts his capital. The confidence of the investor and the 
power to borrow of the business man are two aspects of the same 
conditon, a condition which enables capital to move easily from one 
to the other. 

The statement does not, however, indicate clearly the economies 
which credit effects in the work of the market. In order that this 
may be done it is necessary to examine separately its influence first 
on the work of supplying money, secondly on that of transporting 

The total stock of purchasing power may be conceived as con- 
sisting of three groups, each with its own characteristics, arranged 
like Chinese boxes, the one within the other. The central group may 
be taken to consist only of gold and be known as standard money. 
The second and larger group, which may be described as currency, 
is composed mainly of forms of money which depend on credit and 
are passed from hand to hand as a means of paj^ment ; it includes 
the subsidiary coinage which consists of titles to gold, notes which 
are promises to pay, and also bank deposits which are evidences of 
promises to pay and are transferred from one party to another by 
means of cheques. The third and largest group must be known as 
purchasing power and be taken to include not only currency but also 
all other means of purchase, the most conspicuous of which are bills 
of exchange and the simple book entries which record a power to 
purchase granted, for example, by wholesale houses to retailers and 
by retailers to consumers. These three terms, standard money, 
currency and purchasing power, will henceforward be used in the 
sense just defined, while the term " money " will be employed when 
no particular accuracy is required by the context. 

The distinction between these various forms of money, in itself, 
brings out the normal influence of credit on the stock of purchasing 


power. Credit, employed in this way, gives rise to an important 
economy ; in effect it multiplies the stock of standard money into a 
much larger stock of general purchasing power in the form of pro- 
mises to pay, and, by so doing, enables the community to substitute 
for gold a means of payment which is perhaps more economical, 
certainly more efficient. It should be noticed that these economies 
due to the substitution of paper for gold arise from the function of 
credit in extending the power to borrow. It may also be noticed 
that in consequence of this substitution the volume of purchasing 
power depends on the state of credit, tending to expand when 
credit is good and contract when credit is bad ; but this point is 
outside the normal economies which at the moment are under dis- 
cussion and must be carried forward for consideration later. 

The economy effected by credit in the transport of capital though 
produced by the same method is different in character. It was 
noticed that between the investor and the party who bids for the 
use of his capital there lies a gap due to lack of knowledge. This gap 
is partly bridged with the assistance of the Money Market. But 
even with this assistance the power of any business venture to obtain 
the capital it requires must be determined largely not so much by 
its actual earning capacity as by the estimate which the investor 
forms of the business integrity and abiUty of the parties in charge 
of the venture. In other words, the power of the venture to obtain 
the capital it needs depends very largely upon its credit, upon the 
confidence which its management inspires in the mind of the investor. 
The public recognition of business integrity and abihty which is the 
basis of credit is then a very important means of promoting the free 
flow of capital in the direction required by the public interest, namely, 
in the direction of its highest net yield. The economy effected by 
credit in relation to the transport of capital is therefore very great, 
and is measured by its effects in increasing the productivity of 
capital by enabling it to move readily to those points at wliich it 
yields the highest net return. 

Credit, then, by bringing borrower and lender into closer business 
contact, introduces these two important, normal economies. In 
the first place, it enables Governments and banks — to take the 
most conspicuous examples — to borrow from the public. These 
borrowings recorded in the form of notes and deposits are the 
means by which the stock of gold is multiplied into a larger and 
more efficient stock of purchasing power. In the second place, it 
enables the control over those resources which are not devoted to 
purposes of consumption to be more readily transferred to the 
points at which they can be most effectively employed. 

The higher the level at which credit is sustained in any com- 
munity the larger will these economies be. Inasmuch, therefore. 


credit is a means by which the efficiency of the organization 

the Money Market is increased it must be reckoned as a part of 

e immaterial capital of the country. In international relations 

e advantage to any State of a high reputation is evident enough ; 

is shown in the reduced costs at which its market can draw supplies 

capital from foreign countries, and may be measured, in the 

,se of a country borrowing largely abroad, in terms of millions of 

)unds per annum. It is, however, with the internal advantages 

lat we are principally concerned. 

A part of the immaterial capital of each country consists, then, 

in the normal level of credit or, what is the same thing, in the 

normal level of confidence on the part of capitalists in the business 

integrity and abiUty of those who bid for the use of their capital. 

The yield of this immaterial capital is expressed partly in the form 

of the lower gold reserves which the country needs to hold against 

its paper currency, partly in the more effective application of the 

resources of which it disposes. It would be absurd to attempt any 

detailed analysis of the influences which determine the extent to 

which any country is able to avail herself of these economies ; but 

it may be worth while to notice some of these economies which 

show themselves directly in their effects on the Money Market. 

National character has clearly an important influence on the level 
of credit, and consequently on the development of an economical 
currency. Leoni Levi,^ in 1880, showed the effects resulting from 
the difference between the " phlegmatic temperament of the Scotch 
and English, and the impulsive disposition of the Irish." "The 
Irish," he says, " are constantly alternating between the extremes 
of confidence and distrust. At one time they will avail themselves 
in a most inconsiderate manner of any facility of credit. At 
another, and immediately as credit is in any degree checked, they 
fall into a total want of confidence. In Scotland a sound public 
opinion respecting the currencies operates rather more efficiently 
than any bank restriction Act in economizing the use of gold. A 
person who asks for gold in payment of a note acts, in the eyes of 
the community, in a most unpatriotic manner, and contrary to the 
interests of the country. In Ireland the great body of the 
peasantry have upon the slightest rumour a desire to possess them- 
selves of gold in preference to paper." 

The possibility of an economical and efficient credit currency 
necessarily lies in sustained confidence. This depends not only 
on the character of the people, but also on the stability of its social 
and political institutions. In England political security and the 
growth of strong, old-estabUshed banks of high reputation have 
made possible the development of a currency which in pre-war days 
was, perhaps, the most efficient and, so far as the size of its gold 


reserve was concerned, almost certainly the most economical in the 
world.8 In the U.S.A. a similar development has been hampered 
by exceptional currency and banking legislation, but is now in full 
progress. In Germany and France, on the other hand, where the 
threat of war has always been more immediate, both the forms of 
currency — ^notes and metal — and the still extensive habit of holding 
reserves of this currency at home, are evidence of a lower level of 
confidence and of its cost. 

It seems tolerably certain, however, that the general level of. 
credit is of far greater national importance through its influence 
in enabling capital to move easily to its most profitable employ- 
ments either at home or abroad. Imperfect confidence on the 
part of the small capitalist, and imperfect knowledge on the part 
of the banks, seriously hamper the small Indian entrepreneur in 
obtaining control over the capital he requires to expand his busi- 
ness. " The wealth actually possessed does a very small amount of 
work owing to its inactivity. . . . The difficulty of raising capital 
for industries is mainly the measure, even in India, not of the 
insufficiency or inaccessibility of money, but of the opinion which 
its possessors hold of the industrial propositions put before them."* 

A writer in the EncydopcBdia Britannica,^ speaking of the " deep- 
rooted conservatism and caution of the French people in money 
matters," says : " It is true that they are liable to occasional 
outbursts of imprudence such as led to the loss of great sums in the 
Panama Canal Coy. ; but, as a rule, it is difficult to induce the 
average Frenchman to place his money in anything which he does 
not think a safe interest -5delding security under French law ; he 
almost always wants to invest and not to speculate." The English 
are less cautious, and their investments have been less subject to 
political influence ; their capital has been devoted less exclusively 
to first-class international securities, and has moved more readily 
into foreign railways and industrial undertakings of a more risky 

In Germany the vigour and enterprise of her business men, 
together with the comparative poverty of the country, has made 
the market primarily a domestic organization. The success with 
which her available resources have been applied to the develop- 
ment of industry and trade seems to have been largely due to an 
exceptionally efficient system of intelligence organized by the 
banks. This system has given them an intimate knowledge of 
business men and their undertakings at home and abroad, by 
means of which the " credit " of these business men becomes 
an effective means of obtaining the capital required to give scope 
to their energies. 


THE purpose of the preceding two chapters was to estab- 
Hsh the leading ideas which are to be employed in the 
later treatment of the subject-matter. The object now is 
to recapitulate, in order to bring those ideas more closely 
together ; to carry them a Uttle further in order to present a pre- 
liminary view of the work of the market as a whole ; and, finally, to 
indicate the order in which the subject is to be dealt with in the 
following chapters. 

It was noticed that the organization whose work is to be con- 
sidered includes not only the speciaUzed institutions forming the 
Money Market proper, but the whole of the varied and indefinite 
arrangements concerned in the supply of two services : the manu- 
facture of money and the transport of capital. 

This organization may be conceived as lying between two 
groups : the one, the group of capitaUsts, i.e. of people with 
disposable resources ; the other, the group of business men and 
other parties who apply these resources in their various uses. 
The market supphes the stock of money by means of which these 
resources are administered and at the same time supplies facihties 
by which these resources pass readily from the possession of one 
group into the control of the other. Between these groups Com- 
mand over Capital is transferred in a continuous stream. 

Credit, so long as it is at what may loosely be called its normal 
level, serves simply to facilitate the work of the market. It enables 
it, on the one hand, to multiply the central gold reserve into an 
appropriate quantity of convenient forms of purchasing power. It 
enables it, on the other, to facilitate the movement of resources 
from one party to another ; if a larger fraction of the total 
flow of social resources is devoted by capitaHsts to investment 
purposes, that flow appears on the market as an increased supply 
of capital, is transferred to the parties who offer a price for its use 
and results, without disturbance, in the productive powers of 
society being applied more largely to produce such durable things 
as factories and machinery, and less to the supply of consumables ; 
conversely, if people become less thrifty, less capital is carried by 
the market into the hands of business men, purchasing power is 


applied to direct a larger fraction of the total stream of resources 
to the production of consumables and a smaller fraction to in- 
creasing the stock of fixed plant and other forms of capital. 

But the important influence exerted by credit on the efficient 
working of these processes must be set against the great disturbances 
which are introduced by changes in its general level. Credit was 
defined as a condition which may be expressed on the one hand 
as confidence on the part of the investor, and on the other as a 
power to borrow ; a condition which itself depends on another 
and more general one, namely, the general level of confidence on 
the part of business men in the future outlook. The level of con- 
fidence in general includes therefore the level of confidence between 
the particular class of creditors and debtors, i.e. the level of credit ; 
and a change of confidence, by affecting credit, affects also the 
work done by credit in facilitating the two services performed by 
the market. 

If confidence in the business outlook increases, investors become 
more willing to lend, business men are both more eager and more 
able to borrow, and capital flows more readily from the one to 
the other. But this is not all ; for the stock of purchasing power, 
being also dependent on the level of credit, is also affected. 

It is true that an increase of loans does not necessarily result 
in an increased supply of money, for a loan may be merely a transfer 
of purchasing power ; even so, however, the transfer may result 
in the money being more actively employed. But a more important 
point is the fact that an increase of certain kinds of loans — in 
particular bank advances and trade credit — ^necessarily results in 
the creation of new purchasing power and not merely in its transfer 
from one party to another. 

Hence a general increase in loans involves an expansion in the 
total volume of purchasing power and an increase in the stream of 
Command over Capital passing into the hands of business men ; 
an increase independent of the stream of raw materials and other 
forms of real capital which are available for their use. The competi- 
tion of increased purchasing power for the limited supply of real 
resources naturally leads to a rise in prices ; and rising prices, by 
quickening the anticipation of profitable sales, reinforce the general 
confidence and so lead cumulatively to a further expansion of 
credit. At such times the market is thrown into a state of abnormal 
activity : bank loans expand, new companies are readily floated, 
operations are large and profitable. With dechning confidence 
comes the converse train of effects : contracting credit, a smaller 
volume of purchasing power, lower prices and a market unduly 
depressed and inactive. 

In much the same way, therefore, as a chemical reaction pro- 


ceeds regularly while the temperature of the medium in which it 
is immersed remains constant, and as its action quickens when the 
temperature rises and slackens when it falls, so the operations of 
the Money Market, immersed as it were in a medium of credit, 
proceed regularly when the level of credit is normal, quicken as 
this level rises and slacken when it falls. 

These then are the main ideas with which a preliminary concep- 
tion of the market may be formed : the manufacture of money ; the 
transport of capital ; the normal influence of credit in faciUtating 
these operations ; the effect of changes in the level of credit in 
alternately quickening the activity of the market and plunging it 
into depression. 

The organization in which money, capital and credit work 
in their compHcated ways to produce the phenomena of the Money 
Market has to be examined in the following pages with the object 
of tracing the social economies to which its work gives rise. The 
natural order of the analysis would seem to be to deal first with 
the normal work of the market and then with its work during the 
periods when it is imduly active or depressed ; but it seems im- 
possible to follow this order completely without breaking up the 
subject-matter inconveniently and introducing a good deal of 
tiresome repetition. The actual order adopted will then be some- 
what as follows. In the first place, a fuller account must be given 
of the economies arising from the supply of the various forms of 
purchasing power, and the social evils which result from arbitrary 
variations in supply ; the standard by which this part of the work of 
the market is judged being the technical efficiency of the means of 
payment which it provides and the success with which the supply 
is adjusted to the volume of work to be done. Next will come an 
examination of the costs of production of capital, the nature of 
the economies arising from its use and the work done by the market 
in lowering its supply price ; this work being measured by its 
effects in lowering the cost at which capital is carried to the points 
where its productivity is highest. The work of the market having 
been outlined as a whole, a closer examination must be made of 
the more important parts of its organization, in particular the 
banks and the market for negotiable securities. In the course of 
tliis examinafiOH" it will not be possible to avoid considerable 
repetition ; further, the length at which the different parts of the 
subject-matter are discussed will be adjusted rather to their diffi- 
culty than to their importance. 




THE value of a unit of money, like the value of a unit of any 
other thing, is governed by influences operating through 
supply and demand, and is governed solely by influences 
operating through these channels. The exchange value 
of a yard of cloth tends to fall with every increase in the supply of 
that cloth and to rise with every increase in its demand ; similarly, 
the exchange value of the piece of stamped bullion known as the 
sovereign tends to fall with any increase in the supply of sovereigns 
or their substitutes and to rise with any increase in demand ; in 
neither case can exchange value be affected except through the 
channels of demand and supply. 

This is saying no more than that the general theory of value 
may be applied to explain the purchasing power of the sovereign 
in exactly the same way as it may be applied to explain the exchange 
value of everyday commodities, the rate of interest, or the level of 
wages. This general statement is not in dispute, but it is of some 
importance to lay emphasis upon it. For the theory of money 
contains certain minor peculiarities ; and there is a tendency, if 
not actually to rest the theory on these peculiarities, at any rate 
to give them rather undue prominence, with the result that the 
theory comes to be regarded as a thing sui generis, distinct from, 
instead of a part of, the general theory of value. 

The first of these peculiarities lies in the fact that, with a careful 
definition of terms, it is possible not merely to say that a given 
change in demand or supply will cause the value of the sovereign 
to rise or fall, but to lay down a definite numerical relation between 
these two changes, e.g. that if supply is doubled, value is halved. 
It is this feature to which the Quantity theory gives such great 
prominence. The second peculiarity lies in the fact that the 
causes affecting the value of money are more complex and obscure 
than those governing the value of ordinary commodities. This 
feature strengthens the tendency to regard the theory of money as 


a thing apart ; for it makes it convenient to express the theory in 
a special form — that of a mathematical formula which serves as a 
vice (as Dr. Marshall expresses it), holding together in a compact 
form the set of ideas required to deal with the theory. 

For a brief statement of the Quantity theory no elaborate 
formula is required. It will be sufficient to use a very simple and 
quite general expression — one which is applicable not only to money 
but to any kind of commodity : 

If this equation is applied to express the value of cloth or 
copper, P=the price of the yard or the ton ; D, the amount of 
money exchanged against cloth or copper ; S, the amount of the 
commodity exchanged against money. If, as now, the equation is 
applied to express the value of money, P=the purchasing power, 
or exchange value, of the sovereign. But the meanings to be 
given to S, the supply of money, and D, the demand for money, 
are less obvious ; they must be derived from a general conception 
of the total volume of exchanges. 

During the course of a period of time, say a year, there takes 
place within any country a definite but unknown total of purchases 
or sales. This total may be mentally separated into two parts : 
the one being the sum of all the individual amounts of money 
exchanged against goods (including services) ; the other being 
the sum of all the individual amounts of goods exchanged against 
money. We have, then, a conception of the total purchases or sales 
effected during the year, in the simple form of an aggregate of 
money, S, exchanged against an aggregate of goods, D. In every- 
day thought and language, S, the aggregate of money, would 
naturally be regarded as forming the demand for goods. The 
simple converse leads us to regard D, the aggregate of goods, as 
forming the demand for money ; and it is so regarded for the 
purposes of this theory. There is scope for a good deal of dis- 
cussion in defining exactly what these aggregates S and D should 
be taken to include, and for elaborating the equation in order 
to show the various elements of which they are composed. But 
for present purposes this need not be carried very far. 

S would, perhaps, usually be taken to include coin and bank- 
notes in actual circulation, but not that part which was " hoarded " ; 
it would include also all deposits subject to cheque, without dis- 
tinguishing between that part which was actively employed in 
the purchase of goods and that part held as a reserve against 
contingencies. It would exclude purchasing power obtained by 
the creation of commercial bills of exchange and book debts ; 
for these, separate allowance must be made. Further allowance 


must be made for money transferred in the form of gifts, taxes 
and other payments for which nothing tangible is received in 
exchange. The aggregate of money exchanged against goods 
during the year being so defined, the next step is to recognize 
that each piece of money may be so exchanged several times in 
the course of a single year ; each piece has a " rapidity of circula- 
tion/' It is convenient to take account of this by slightly elabo- 
rating the formula and substituting for S, nxr, where n = the 
number of units of money and y = their average rapidity of 

D does not, of course, include either those goods which are 
not exchanged or those which are exchanged directly against 
other goods ; it includes only that aggregate which is exchanged 
against money. 

This aggregate we may call T, though it is not a total in quite 
the usual sense of the term ; for the units of which it is composed 
— ^the quantities of iron, cotton, wheat, human services and so 
on — are not homogeneous and cannot be added together. It 
must be conceived as a vast collection of different quantities of 
different things, which can be expressed only in the form of an 
immense list. It is clear that each kind of thing entering into 
this total may be exchanged once or many times ; that goods, 
like money, have a certain average " rapidity of circulation." 
Further, the average number of times these goods are exchanged 
may alter considerably ; it rises, for example, with the growth 
of public joint-stock companies whose shares are continuously 
sold and resold on the Stock Exchanges ; and it falls when, in 
time of war, many goods which would normally pass through a 
series of hands are supplied by the manufacturer direct to the 
Government. This " rapidity of circulation " of goods may, like 
that of money, be expressed separately in the formula, or it may 
be allowed for by reckoning the yard of cloth which is sold four 
times as entering into T, not as one yard but as four. It is, how- 
ever, not usual to express this rapidity of circulation separately, 
and we need not do so now. The equation may, then, be written 
down in the simple form : 


It cannot be maintained that this formula leads to any very 
clear conception of P, the value or purchasing power of the 

T has been regarded as the aggregate of the items of a pro- 
digious invoice, each item being a separate statement of the total 
quantity of some one kind of goods exchanged against money 


during the course of the year. The value of P must then be 
conceived as an aggregate composed of a minute fraction (the 

-Lth) of each of these items ; or, more concretely, as this ag- 

gregate of small quantities compounded into a " composite com- 
modity." It is a conception of the purchasing power of the 
sovereign from the point of view of a community regarded as a 
single person spending the whole of its money in the purchase 
of the whole of the commodities sold. This conception serves 
well enough in considering the simpler changes in the value of the 

It is clear that if the sole change occurring is that w or r is 
doubled or halved, then the value of P is halved or doubled, 
that is to say, the size of the composite commodity purchasable 
for a sovereign is one half, or twice, as large as before. The 
formula, therefore, brings out clearly the main pecuUarity in the 
causes determining the value of money : namely, that the value 
of the imit varies inversely with changes in the total quantity. 
The reason for this peculiarity has been discussed on pp. 9 and 10. 
Further, if T is doubled, in the sense that the quantity of each 
of the things of which it is composed is doubled, the value of P 
is also doubled ; for the sovereign will purchase a composite 
commodity of exactly the same constitution as before and of 
double the size. But in practice, of course, the changes that occur 
on the side of T are not so simple. What actually happens is 
that changes are simultaneously occurring in opposite directions ; 
some things are increasing while others are diminishing in quantity, 
with the result that the constitution of the composite commodity 
— the proportions of its ingredients — alters. Even from the point 
of view of society as a whole it may be impossible in such cases 
to say whether, as a result of the change, the purchasing power 
of the sovereign has risen or fallen ; it will buy more of some 
things, but it will buy less of others. And the matter becomes 
more compUcated when we take account of the fact that in- 
dividuals spend their money on the various kinds of goods in pro- 
portions determined by their individual tastes ; so that a change 
of the kind considered may raise the purchasing power of the 
sovereign to some while lowering it to others. 

In practice, of course, a definite if somewhat arbitrary solution 
is foimd by the use of index numbers. For the comprehensive 
composite commodity with which we have been dealing there is 
substituted a simpler composite commodity made up of a relatively 
small number of representative goods. The constitution of this 
simpler composite commodity, that is to say, the ingredients of 
which it is composed, is adapted to the nature of the consumption 


of the particular economic group to which it relates. And changes 
in the size of the composite commodity purchasable for a sovereign, 
or what is the same thing, changes in the price of this composite 
commodity, are taken as the index showing the rise or fall in the 
value of the sovereign in the estimation of the particular economic 
group concerned. The manner in which the value of the sovereign 
alters in response to such causes as a change in tastes or in the 
nature of commodities produced, and the precise method by 
which these changes are measured need not concern us. The 
considerations which have been touched on are intended only 
to establish two simple ideas : the one, that a tolerably clear con- 
ception of the purchasing power of the sovereign may be formed 
in terms of the size of a composite commodity ; the other, 'that 
an accurate conception of changes in this purchasing power may 
at times be impossible, and must be left to the more or less 
arbitrary decision of an index number. 

The value of the unit of money may be expressed in terms of 
the fraction of a composite commodity for which a sovereign will 
exchange. It may also be expressed in terms of the number of 
sovereigns which will exchange for that composite commodity. 
In other words, P, the purchasing power of the sovereign, and 

=, the general level of prices, are modes of expressing the same 

idea ; the one expression is the reciprocal of the other. That being 
so, the causes determining the general price level may be expressed 
in terms of the causes determining the purchasing power of the 
sovereign, and those again in terms of the Supply and Demand of 
money, or T and nXr. To put the matter more concretely : no 
change can occur in the general price level except as a result of 
causes affecting the quantity or rapidity of circulation of goods 
(including services), or the quantity or rapidity of circulation of 
money. For example, a rise in wage rates, i.e. a rise in the price 
and not in the quantity of certain of the things offered against 
money, cannot in itself alter the general price level ; though, of 
course, such a change will be followed by a rise in the price level if 
it leads to reduced output or if it leads, as during the war, to an 
expansion in the supply of money. 

The Quantity theory of money has been so long a centre of 
controversy that it would be absurd to attempt any detailed 
criticism within the limits of this chapter ; nevertheless, one or 
two general considerations may be touched upon. 

It will be noticed that much of the apparent simplicity which 
makes the theory so attractive to the mind disappears on closer 
acquaintance : special allowances must be made for money pay- 
ments against which no goods are received, for money temporarily 


hoarded and so on. However, the accuracy of the theory, when 
the terms in which it is expressed are properly interpreted, can 
now hardly be disputed ; the question is one rather of the con- 
venience which it affords in the statement and solution of monetary 

In touching upon that question it must be noticed that the 
theory gives gieat prominence to the simple numerical relation 
connecting changes in supply and demand with consequent changes 
in the value of the unit of money, the sovereign. By so doing it 
brings out with especial clearness the consideration that the amount 
of work done by the total stock of money is independent of the 
size of that stock : it shows, for example, that if, without any other 
change, the world s stock of gold money were doubled, the addi- 
tional gold would add nothing to the efficiency of the monetary 
system ; the doubled stock would carry through the same amount 
of money work as before at a price level twice as high ; the resources 
employed in the production of the additional gold so used would 
have added nothing to the well-being of society. It is an advantage 
of the theory that it enables this simple numerical relation to be so 
clearly seen ; but the advantage is gained at the cost of attracting 
attention to that which is exceptional in the causes governing the 
value of money, rather than to that which is common in governing 
alike the value of money and other things. It seems to be true 
that for the imperfect solution of most practical money problems 
(which is all that is attainable), it is sufficient to know that an increase 
or decrease in the supply of money tends to cause a fall or a rise in 
the value of the sovereign ; the fact that there is a tendency for 
this consequent change to be proportionate to the change in supply 
seems to be a matter of minor importance, for it is so intermingled 
with other tendencies that its existence is beyond the strength of 
statistics to detect. 

Further, this theory deals only with the relations between the 
total demand for money and its total supply. It does not construct 
this total demand from the individual demands on which it rests ; 
and, indeed, it throws little or no light on the nature of this indi- 
vidual demand or the manner in which it is satisfied. On the 
grounds, therefore, both of convenience and completeness the theory 
is supplemented in the following chapters by a statement based on 
the evidence given by Dr. Marshall before the Royal Commission of 
1888, on Recent Changes in the relative values of the Precious 

As a preliminary to further discussion, it is convenient to notice 
the different aspects in which money may be regarded. In dealing 
with the Quantity theory, it is considered primarily as a quantity 
of counters, in terms of which the values of aU other goods are 


measured ; when discussing the individual demand for money, it 
is regarded as a stock of instruments, Hke trade tools, yielding 
specific services ; and later, when dealing with banking, it is con- 
ceived rather as a title to resources in general, or as a quantity of 
Command over Capital. 


THE statement that money is a means of exchange is 
not quite complete. It is true that money is the means 
by which each person is enabled more easily to exchange 
his owTi product for the products of other people, and it 
is true that this is much the most important part of the work 
which it does ; but over and above this it is the means of effecting 
payments which can hardly be described as exchanges ; for example, 
allowances made by father to son, the payment of rates and taxes 
and, perhaps, certain kinds of loans. It seems therefore to be more 
accurate and more convenient to describe money as a means of 
effecting pajmients. 

In a modem community each person with resources at his dis- 
posal needs some means by which he can employ these resources in 
order to obtain goods from other parties, to pay his dues to the 
State and to meet more uncertain demands to which he may be 
exposed. The resources at his disposal are not usually in a form in 
which they can effectively be employed for these purposes ; a steel 
manufacturer cannot readily pay his rates with steel billets or a 
workman buy bread with personal services. Each therefore will 
find it convenient to hold a part of his resources in the form of a 
stock of something which, being generally acceptable and easily 
transferable, serves as general purchasing power and may be readily 
passed from hand to hand as a means of making payments. 

He will of coiu^e have to forego interest upon the resources which 
he invests in this particular form of a stock of money, but he will 
obtain instead facilities for making payments, which may be 
expressed as a return of convenience and security. His stock yields 
him an income of convenience, for it reduces the cost and trouble of 
effecting his current payments ; and it yields him an income of 
security, for it reduces his risks of not being able readily to make 
payments arising from contingencies which he cannot fully foresee. 
The investment of resources in the form of a stock of money which 
facilitates the making of payments is then in no way pecuUar ; it 
corresponds to the investment by a merchant in the office furniture 
which facilitates the dispatch of business, to the investment of the 


farmer in agricultural implements which faciUtate the cultivation of 
his land, and indeed to investment generally. 

Such being the nature of an individual's demand for money, we 
have now to consider the causes governing its amount. In order to 
do so, let us first state the general principle on which an individual 
distributes his resources among their various uses, and then pass on 
to consider the causes determining the amount which he invests 
in this particular use — money. 

This general principle is familiar enough. As a person extends 
the apphcation of resources in any particular use, the yield from 
each successive unit of resources so applied satisfies a less and less 
urgent need. Accordingly he presses their employment in each use 
up to that point where in his judgment the marginal yield is equal 
all round ; for if this yield differed as between any two uses it would 
pay him to transfer resources from one to the other. Resources 
devoted to consumption supply an income of immediate satisfaction ; 
those held as a stock of currency yield a return of convenience and 
security ; those devoted to investment in the narrower sense of the 
term yield a return in the form of interest. In so far therefore as 
his judgment gives effect to his self-interest, the quantity of re- 
sources which he holds in the form of money will be such that the 
unit of resources which is just and only just worth while holding in 
this form yields him a return of convenience and security equal to 
the yield of satisfaction derived from the marginal unit spent on 
consumables, and equal also to the net rate of interest. 

This distinction between the yield of convenience and security 
brings out the consideration that the stock of money held by a 
business man serves not only to effect his current payments but also 
as a first line of defence against the uncertain events of the future. 
This first line is supported by his power to borrow from his banker 
and perhaps by a holding of Stock Exchange securities. It may be 
noticed as a corollary that the banks and the Stock Exchange, by 
increasing the faciUties for borrowing and for selling securities, in- 
crease the power of business men to make payments in times of 
individual necessity ; in effect they insure him in part against his 
individual financial emergencies, and so tend directly to reduce the 
stock of money which he needs to hold. 

If we arrange a business man's investments in order of their 
marketability, we may regard his resources as distributed among a 
series of uses ranging from his stock of the supremely acceptable 
thing, money, up to his investments in the permanent plant from 
which he draws his main money income. This arrangement con- 
veniently illustrates the essential similarity between the distribution 
of resources by a business man and the distribution effected 
by a bank, where the two main considerations, the need to 


meet current and contingent demands and the need to earn a profit, 
are shown in clearer contrast. In order to meet current and con- 
tingent payments over the counter or through the Clearing House a 
banker holds the till money and the balance at the Bank of England 
which (in normal times) yield him only an income of convenience 
and security. His second and third lines of defence are his short 
loans and his holdings of Stock Exchange securities, readily market- 
able and yielding only a low rate of interest. The rest of his re- 
sources, like those of the business man, are employed in the more 
profitable uses from which they cannot readily be withdrawn. 
So, too, with the Bank of England. The stock which 5delds an 
income of convenience and security is in this case the gold reserve, 
for gold is the only thing which is generally acceptable as a means 
of effecting the payments which it may be called upon to make. 
Behind this, as with the other banks, are ranged in order its short 
loans, its holdings of securities and finally the more permanent 
uses in which its resources are engaged. 

Given this general principle on which business men and bankers 
alike allocate their resources among competing uses, let us turn 
to consider the specific causes determining the quantity of re- 
sources held in the form of money. The demand of an individual 
for consumables, machinery or Stock Exchange securities is the 
amount of resources which he devotes to the purchase of these 
things ; similarly, his demand for money may be stated as the 
amount of resources which he devotes to this particular use. On 
what does the volume of this particular demand depend ? The 
answer, already given, is that it depends on the volume of his 
current and contingent payments ; but it seems to be of some 
importance to investigate this a Uttle more closely. 

It is clear enough that the size of the money stock held by a 
business man depends mainly on the volume of his current trans- 
actions, but it is not quite so obvious that it depends also on the 
degree of uncertainty in his business situation. 

Contrast the position of two merchant firms, let us say the 
" shipper " of woollen goods, who buys from the home manu- 
facturer only in response to foreign orders, and the " merchant " 
who buys similar goods in anticipation of foreign demands ; they 
may both need to hold the same volume of money to carry through 
their current transactions, but the latter firm will need to hold a 
larger stock of money (or other readily available resources) because 
of the greater uncertainty in the incidence of his receipts and pay- 
ments. Again, two banks may need about the same amount of till 
money and reserve at the Bank of England to meet the current 
demands made over the counter or through the Clearing House ; 
but if, as we may suppose, the one bank differs from the other in 


the circumstance that its deposits are composed predominantly 
of a few large balances lodged by foreign bankers, it must hold a 
larger reserve against contingencies ; its stock of money will need 
to bear a larger proportion to its total payments than that of its 

Even in normal circumstances, therefore, the size of the stock 
of money held by a business man depends partly on the volume of 
his current transactions, partly on his individual business out- 
look. The distinction is, perhaps, even more marked when this 
outlook changes. For when the general outlook is improving, 
rising confidence inevitably encourages business men to invest 
their resources more closely — ^to be less reluctant to " lock up 
their capital " ; just as it encourages the banks to reduce the pro- 
portionate amount of their " cash " by expanding their loans. 
On the other hand, when confidence is decUning, the amount of 
money which a business man requires to carry through his current 
transactions may be no greater than before ; nevertheless, his 
apprehension of the demands that may be made on him is likely 
to cause a great increase in his demand for money as a reserve 
against contingencies. If apprehension becomes general, there 
may follow a condition of crisis accompanied by a great and urgent 
demand for money, not so much to meet current payments as to 
provide against prospective payments whose volume is unknown. 

These considerations lead to a definition of the demand for 
money rather different from (though not inconsistent with) that 
laid down by the Quantity theory. In that theory the demand 
for money during the year is taken to be the aggregate of goods 
(and services) exchanged against money during that period. If 
we add to this aggregate of goods, the total of allowances, dues to 
the State and other similar transfers for which money is employed, 
we obtain the total volume of payments. Can this total, the 
volume of payments to be effected, be properly regarded as forming 
the demand for money ? Tliis question must be answered in the 
light of the considerations which have just been noticed. 

It seems undeniable that the volume of payments is the sole 
source of the demand for money ; for the essential function of 
money is to serve as a means by which payments are facihtated. 
In order to carry through his payments quickly and conveniently 
each person holds a part of his resources in the form of a stock of 
money. The size of that part of this stock which he holds to 
carry through current transactions depends directly upon the 
volume of his payments ; as the volume of his business trans- 
actions rises or falls, so he makes large or smaller provision of the 
means by which these transactions are carried through. But the 
size of that part of this stock which he holds as a first line of defence 


against emergencies depends less directly upon the volume of his 
payments ; it depends upon his estimate of contingent payments, 
and consequently varies with his state of mind, or, more concretely, 
with tlie business outlook. If he is apprehensive, his demand for 
money rises, and prices tend to fall as a result of the withdrawal of 
money from active circulation into reserve ; if he is confident, his 
demand for money for the purpose of a reserve falls, and money 
is released for active circulation, with a consequent tendency to a 
rise of prices. It seems reasonable, therefore, to regard this latter 
part of the aggregate money stock as a reserve whose size is regu- 
lated largely by the general level of confidence — a reservoir from 
which money flows into active circulation when times are good, 
and into which money flows from active circulation when times are 
bad. This ebb and flow of money would, perhaps, usually be 
regarded as changes in the volume of hoarding ; but the char- 
acteristic of a hoard is its uselessness, and the characteristic of a 
reserve lies in the fact that it does money work, though of a rather 
different kind from that of money in active circulation. Accord- 
ingly it seems that theory is brought into closer relation with the 
facts when we recognize that part of the demand for money arises 
from the need to make provision against contingent payments, and 
that this part of the demand fluctuates in response to changes in 
the general condition of confidence in some measure independently 
of the volume of payments. 

The discussion leaves a choice of two forms in which the demand 
for money may be expressed. Just as the demand for agricultural 
implements is derived from their yield of services in cultivation, 
and is represented as the quantity of resources devoted to this 
use, so the demand for money, derived from its yield of convenience 
and security in effecting payments, may be represented as the 
quantity of resources held in the form of a money stock ; this 
conception is completely in harmony with the preceding discussion, 
and is apparently that adopted by Dr. Marshall when giving his 
evidence before the Gold emd Silver Commission. Alternatively 
we may go a step farther back and regard the demand for money as 
represented by the volume of payments to be effected ; interpreting 
this as the estimate of the volume of payments, present and 
prospective ; this view has the advantage of being more easily 
realized and more closely in touch ^\ith the origin of the demand. 
The choice between these two forms of expression is one to be 
determined on grounds of convenience. 

ImpUcit in this discussion are three considerations. First, that 

the individual's demand for money is expressed and satisfied in 

just the same way as his demand for ordinary commodities ; he 

distributes his resources in such a way as to satisfy each need 



down to the same level of urgency. Secondly, that the sum of 
these individual demands constitutes the total demand for money. 
Finally, that this total demand contains a peculiarity found only in 
the theory of money ; the nature of this peculiarity and its cause 
have been discussed on pp. 9-10. 

The question now arises — What are the specific properties 
demanded in the thing which is to serve as money ? 

These properties have already been indicated in part. It is 
clear that the first and all-important characteristic of money must 
be general acceptability ; it is this characteristic which gives it its 
general purchasing power and consequently enables it to serve as 
an effective means of making payments. Logically, perhaps, this 
essential property of money may be held to include the minor 
quaUties on which the technical efficiency depends ; for it can 
hardly be generally acceptable in the fullest sense of the term unless 
it has those properties of portability, divisibihty, durability and so 
on which enable it to be readily transferred in small or large 
amounts from one party to another. 

A discussion of these qualities would be of little interest ; in 
any case it, would be hardly practicable in any short space, for the 
kinds of payments to be made differ widely, and each kind sets up 
a demand for a form of currency having the particular technical 
qualities required for its own purpose. Wage and retail payments 
between people who have no great faith in the trustworthiness of 
banks or governments give rise to the need for a metallic coinage, 
while the transfer of funds on a large scale from one place to another 
calls for some more developed form of currency of the nature of 
cheques or bank drafts. 

So far the properties considered have been those which are 
important in the currency, i.e. in the media which can be passed 
readily from hand to hand as an effective means of making current 
payments. More difficult questions arise in connexion with the 
properties required in the use of money as a standard of value, i.e. 
as the unit in which contracts to make future payments are ex- 
pressed. When any party enters into a contract involving a future 
payment, when, or example, he buys goods by giving an undertaking 
to pay a number of units of money at some distant date, it is 
evidently of the first importance, both to the party who will pay 
these units and to the party who will receive them, that their 
exchange value, their purchasing power, shall not have altered in 
the interval ; or, at any rate, that it shall have altered only in a 
way which was easily calculable by both. If the unit in which the 
one side of the contract is expressed varies in a way which is not 
foreseen, economic adjustments are rendered more difficult and 
uncertain. Those who are in the best position to anticipate the 


change can profit at the expense of the less well-informed, business 
generally becomes more risky, and there occur transferences of 
wealth quite arbitrary in character and quite incalculable in their 
social effects. The demand for money, therefore, requires that it 
shall possess this further property, that each unit shall be free 
from arbitrary changes in value. 

The conclusions of this chapter are then that the demand for 
money arises from the volume of payments, and is a demand for 
media adapted to two main purposes, and consequently possessing 
two distinct properties. They must possess, first, the general accept- 
ability and those minor qualities which fit them to serve as a con- 
venient means of effecting immediate payments. They must 
possess, secondly, the stability of value which enables them to serve 
as a suitable basis for contracts involving pajnnents to be made in 
the future. There are therefore two main questions to be dealt 
with on the side of supply. The one is concerned with the technical 
efficiency of the means of payment and the economies to which they 
give rise ; the other is concerned with the means by which the unit 
of money can be given stability of value. These questions will be 
taken up in order. 




HE first question to be dealt with on the side of Supply 

is that of the various forms of purchasing power manu- 

■ factured by the market, and their technical efficiency as 

"^ means of making payments. 

If it is true that general acceptability is the essential character- 
istic of a currency, one might suppose it impossible to produce any 
V currency which could displace gold. Gold is acceptable at cdl times 
and at all places. This for two reasons : the first, more important 
in the past, lies in the fact that it has a high value apart from its 
vvalue as money ; the second, of the greatest importance now, arises 
from the fact that it is the medium in terms of which contracts of 
all kinds are expressed, and consequently the means by which those 
contracts may unfailingly be discharged. Gold is then the one 
universally acceptable medium in this sense that it is the ultimate 
means by which transactions between any two parties may at 
all times be discharged throughout the greater part of the world. 

But it is not the universally acceptable medium in the sense 
that it is the most convenient means by which transactions may be 
carried through. Indeed, the perfect negotiability of gold is itself 
one of the main causes of its inferiority in competition with other 
forms of currency, for it exposes the party who holds or transmits 
it to considerable cost and risk in safeguarding himself against loss. 
Hence it becomes more convenient in practice to substitute for the 
metal itself titles to gold which maybe limited in their negotiability, 
and may be held or transmitted from place to place with greater 
security and lower cost. This substitution evidently contributes 
materially to the efficient dispatch of business. Some idea of its 
importance : some idea, that is to say, of the importance of the 
economy effected by the market in manufacturing convenient 
forms of currency, may be formed by contrasting the hypothetical 
condition in which gold was the only means of payment with 
the conditions which actually exist. 

If gold were the sole means of making payments in international 
trade, every import and export would be duplicated by an export 

and import of metal ; millions of pounds of gold would be con- 



stantly in course of transit ; and the costs of carriage and risks 
of its transmission would form a very heavy tax on all trade between 
one nation and another. In actual conditions, of course, gold is 
not so used. It remains the ultimate means by which international 
indebtedness may be discharged ; but it is now employed only when 
other means are unobtainable, or are obtainable only at a higher 
,' cost. Bills of exchange are far more economical in use. They are 
promises to pay gold usually at some future date ; but before that 
date is reached bills requiring the movement of gold in one direction 
are set off by other bills requiring the movement of gold in the 
opposite direction, and the actual transmission of the metal is 
avoided. Even when these bills do not fully set off one another, 
and there is a balance of indebtedness to be met, it may still be 
cheaper to settle that balance by the export of other readily market- 
able goods, in particular. Stock Exchange securities. The cost 
of effecting payments by means of gold is equally evident in home 
, trade. Its perfect negotiability enables a thief to make full use 
of it, while its weight makes it a costly means of settling distant 
transactions. If it were the sole means of effecting payments, 
business men would need to build strong rooms and safes to 
safeguard their stocks of money, and would incur heavy costs 
in transmitting it from one place to another. 

These are the conditions which form a basis of comparison, on 
which one may rest an estimate of the importance of the economies 
arising from the work of the market in substituting more con- 
venient forms of purchasing power. The market effects these 
economies in substantially the same way in all highly developed 
countries. In foreign trade it substitutes telegraphic transfers, 
bills of exchange and securities ; in home trade it enables each 
country, in effect, to take a quantity of the metal from the inter- 
national gold market, to hold this as a stock, and to multiply it for 
internal use into a larger stock of purchasing power in the typical 
form of titles to gold. 

Prior to the war, of course, gold was itself largely used for 
currency purposes, the amount actually in the hands of the public 
being in the neighbourhood of £80 m.^ Since that date Treasury 
notes, a cheaper though not necessarily a more convenient form of 
currency, have been issued to the extent of about four times that 
figure, and gold has been withdrawn into central reserves to serve 
as a means of making payments abroad, and as the basis of the 
internal stock of paper currency. 

In England the supply of titles to gold into which the central 
stock is multiplied takes many forms, each adapted to some par- 
ticular kind of payments. 

Substitutes for gold which are printed on silver and bronze 


are evidently more convenient for the minor transactions in which 
they are employed than would be the minute portions of gold 
which they represent. Their use in wage and retail payments is 
considerable, the total quantity of silver employed in the United 
Kingdom in 1910 being about £24 m.' 
^ Titles in the form of bank-notes are more convenient than 
gold for certain kinds of transactions, but their use is very limited. 
In England, Bank of England notes are employed, for example, 
in payments such as solicitors' settlements which must be made 
in full legal form, and by holiday-makers in places where they are 
not known ; but the average amount actually in the hands of the 
public in pre-war days probably did not exceed £8 m. Notes issued 
by Scotch and Irish banks are used for more general purposes, but 
amounted at the same date only to about £15 m., while the total of 
those issued by provincial banks in England was only a few hundred 
thousand pounds. At the same time the annual issue of Postal 

V and Money Orders, especially adapted for small and distant pay- 
ments, was about £96 m. 

Last in order of development and much the most important 
are cheques, which are titles to gold one stage further removed ; 
for they are not direct promises to pay gold, but orders drawn by 
one party on another party, the banker, who undertakes to pay 
them in gold. They depend for their acceptability, first on con- 
fidence in the drawer, secondly, on confidence in the banker on whom 
they are drawn; if this confidence fails their use ceases. Given 

•^ this confidence, however, cheques are by far the most efficient 
form of currency yet invented, and are especially adapted to make 
distant payments of large and irregular amounts. They are 
quickly " cleared " by an efiicient system of central and local 
Clearing Houses. They carry with them a title to gold ; they 
form a convenient record of transactions ; their negotiability may 
be restricted in a manner which makes them practically valueless 
to anyone but the owner; and, finally, they may be adapted 
in amount to the needs of each particular operation. By means 
of cheques, bank deposits form, as it were, an ad hoc currency, a 
currency created in adaptation to particular payments as they 
arise. The volume of this currency is to be measured by the 
volume of bank lodgments, or rather by that part of them made 
specially for the purpose, namely, lodgments on current account. 
Only three or four banks distinguish lodgments on current account 
made for cheque-making purposes from those on deposit account 
made in exchange for a rate of interest. If these banks may be 
properly regarded as representative in this respect of the whole 
system, the total lodgments forming the basis of the cheque 
currency in England amounted in 1913 to about £560 m. (cf. p. 128). 


About one million cheques were drawn each working day, while the 
aggregate value of cheques and bills pcLssing through the Clearing 
Houses in the course of the year reached a total not far short of 
£17,000 m.8 

Broadly speaking, the total volume of lodgments on current 
account may be regarded as equivalent to a stock of bank-notes 
of similar amount held in the pockets of the public. When an 
account -holder pays away a cheque of £5 the effect is substantially 
the same as when a note-holder pays away a £5 note. The cheque 
is paid into another account, the note goes into some one else's 
pocket ; the total volume of lodgments and the total stock of notes 
outstanding remains unaffected. In the one case an individual 
makes over to his banker the use of resources and receives in 
exchange the right to draw cheques for an equivalent amount as 
and when he needs to make payments ; in the other, he makes 
over the use of resources in exchange for an equivalent amount of 
ready-made currency available for the same purpose. 

In addition to the various forms of currency manufactured by 
the speciaUzed institutions of the market is the purchasing power 
created by manufacturers, merchants and others when they allow 
their customers to buy goods from them on an implicit promise 
to pay recorded in the form of a book debt. It may be objected 
that this system of trade credit does nothing but postpone pay- 
ment, that it merely defers the use of currency and consequently 
adds nothing to the average volume of purchasing power. This 
would be only partially true if the total volume of book debts 
were always about the same ; for although in that case the creation 
of new book debts would proceed concurrently with the extinction 
of old book debts by the use of currency, it would still be true that 
the average volume of purchasing power had been increased by the 
mere fact that payment was deferred. The average volume of 
these deferred payments would still constitute a net addition to 
the total stock of purchasing power, for corresponding to it would 
be an average volume of goods purchased without the use of currency. 
The significance of book debts, however, lies less in the addition 
which they make to the average volume of purchasing power than 
in the ease with which they are expanded and contracted, and in 
the fact that these variations are free from any control on the 
part of the market organizations whose business it is to regulate 
the supply of purchasing power. If, for example, the immediate 
outlook is favourable and business men wish to increase largely 
their stocks of materials and finished goods, their abiUty to purchase 
against book entries constitutes a net addition to the total volume 
of purchasing power in the same way as, in similar circumstances, 
would an expansion of cheque currency. But while the latter 


form of expansion is more obvious and can be dealt with by 
the Bank of England or the banks generally, the former kind 
of expansion is quite beyond their control. These considera- 
tions are, however, bound up with the question of the regula- 
tion of the supply of purchasing power and must be dealt 
with later. 

It should be noticed that the implicit promise to pay represented 
by a book debt is frequently embodied in an explicit promise in 
^ the form of a bill of exchange or promissory note. Some of these 
bills and notes may be passed from hand to hand, and so used as a 
means of payment in a number of successive purchases ; in so far 
as they do so, they multiply the purchasing power created by the 
book debt which they represent. It seems very improbable, how- 
ever, that in English home trade their effect in this way is at all 
considerable. Their importance seems to lie rather in their effect 
in converting a book debt into a form of security which enables 
the creditor, by discounting the bill, to replenish the resources at 
his disposal. 

This description of the various forms of purchasing power in 
use in the United Kingdom suggests the enormous increase in the 
technical efficiency of the means of payment due to the market. 
The stock of gold is expanded by speciaHzed organizations into a 
larger stock of currency in forms which greatly lower the cost of 
making near and distant payments. It is further expanded by 
the more informal organization of the market into a still larger 
volume of purchasing power in forms far more efficient than gold 
as a means of payment. This total volume is composed essentially 
of titles to gold in the form of promises or orders to pay ; it is based 
on confidence or credit. The normal level of credit, that is to say, 
the normal level of confidence in the Government, the banks and 
the business men of the country, is the condition which enables 
the market to substitute these more convenient means of payment 
for gold ; it determines the multiple which relates the stock of gold 
to the total volume of purchasing power ; and is consequently 
the main determinant of the proportionate size of the gold reserve. 
The use of credit to effect these normal economies brings with it, 
however, serious disadvantages. It makes the volume of purchasing 
power dependent on the state of credit. If the use of credit could 
be properly controlled it would bring with it the added advantage 
that the volume of purchasing power could be readily adapted to 
the volume of money work to be done. In fact, however, this 
control is imperfect, and changes in the level of credit bring with 
them great changes in the volume of purchasing power, which, 
being in no close relation to changes in the volume of money work, 
cause changes in the value of the unit of currency, i.e. the level of 


prices, and introduce very important disturbances in the adjust- 
ment of social resources to social needs. 

As already stated, the practice of multiplying a central stock of 
gold into a larger and more elastic supply of titles to gold extends 
to all developed countries ; but the particular form of these titles, 
and consequently their efficiency, varies a good deal as between 
one country and another. In the United States pohtical influences 
have greatly checked the development of the most efficient forms 
of currency and, until recently, loaded the country with heavy 
stocks of gold and silver inefficiently employed. Nevertheless, the 
cheque system in this and other English-speaking countries has 
been able to take its proper place as the most important of the 
means of payment in use. By way of illustration it may be noticed 
that the proportion of the total amount of payments made by 
cheque in the United States has been estimated to be no less than 
92 per cent of the whole.® 

It seems likely that in Germany and France the main influence 
determining the form of the currency has been the political and 
social insecurity due in part to the constant exposure to wars on 
their own territory. In such conditions it is likely that the powers 
exercised by the State will be more extensive than elsewhere, and 
also that the general level of confidence will be too low or too un- 
stable to make profitable the supply of paper currency by parties 
other than the State itself. 

Prior to the recent war the currency of Germany consisted 
mainly of the £120 m. or so of notes issued by the Reichsbank, an 
organization subject to the control of the Imperial Chancellor, 
probablyabout £100 m.w of gold and £50 m. of other metal coinage 
(excluding reserves). It was a frequent complaint of German 
writers that people held unduly large amounts of this currency in 
their cash-boxes and were unwilling to adopt the more economical 
plan of lodging their spare resources with a banker.ii The 
imperfect confidence which this habit suggests is no doubt largely 
responsible for the fact that the cheque system has made compara- 
tively little headway in Germany, though recent legislation designed 
to encourage it may now hasten its development. As the greater 
part of the German currency is clearly not convenient for making 
payments at a distance it has been supplemented by the develop- 
ment, mainly under State control, of the so-called " giro " system by 
which the Reichsbank, the Post Office, and a number of other 
institutions undertake at a very low charge to make pajmients at 
the request of one party to other parties situated elsewhere. This 
system is already on a very large scale and is being developed 

In France similar conditions have led to substantially the same 


results. The Bank of France, a quasi-state institution, supplied 
notes which amounted in 1914 to some £240 m., and with about 
£200 m. of gold and £60 m. of silver formed the main part of the 
currency in the hands of the public. i^ There are the same complaints 
that the people retain too large a quantity of this currency in their 
own possession, the same appreciation of the advantages of the 
cheque system and the same hope of its extension.^* Distant pay- 
ments are made on a very large scale by a giro system similar to that 
of Germany, and developments of this system are still in progress. 


THE previous chapter dealt with the various forms in 
which units of money were suppUed by the market, 
considered in respect of their efficiency as a means of 
effecting payments. The present chapter is concerned 
with the second main question on the side of supply: the unit 
considered in respect of its stability of value, i.e. of its suitability 
to serve as the basis of contracts involving future payments. The 
question cannot be made a simple one ; moreover its parts are so 
interrelated as to make any simple order of development difficult 
to find. It will be as well then to begin with setting down plainly 
the order in which the matter is to be treated. It will be con- 
venient, in the first place, to deal with certain minor complications 
arising from the fact that the stock of money is not homogeneous. 
These being removed, the main causes determining the stability of 
the unit of value can be set out, not with a view to adding anything 
to the previous discussion, but in order that the argument may 
proceed directly from the basis on which it ultimately rests. It 
will then be possible to distinguish the main causes of instability, 
and to follow this up by a discussion of the social importance of 
the consequent disturbances. Any full discussion of the various 
methods by which these disturbances can be removed or alleviated 
is outside the scope of this book ; but some indication will be given 
of the nature of the remedies, and this wiU be followed up a little 
further in the course of a more detailed discussion of the banking 

We may begin by considering a little more fully the nature of 
the stock of money supplied by the market. As already noticed, 
this stock may be regarded as arranged in three concentric rings. 
The core is composed of gold, and may be known as standard money ; 
it is employed directly on money work only to a small extent, its 
main use being to serve as a basis for the supply of more convenient 
means of effecting payments. This gold is multiplied by the special- 
ized institutions of the market into a larger stock, consisting mainly 
of the subsidiary coinage, bank notes and deposits. The whole of 
this depends for its acceptability on public confidence in the 
parties issuing it, that is to say, on credit. It circulates from hand 


to hand, and may therefore be described as currency. The supply of 
currency is expanded into a still larger stock of purchasing power by 
means of book debts and other means of purchase, the extent to 
which this expansion occurs depending, again, mainly on the state 
of credit. The general character of this stock leads to the first three 
considerations which have to be dealt with. 

In the first place, it is evident that the stock is not perfectly homo- 
geneous. Each of the several parts of which it is composed is 
adapted to its own particular use ; each is in some degree indepen- 
dent of the others, and subject to its own special conditions of supply 
and demand. The supply of gold for monetary purposes depends 
mainly on the activity of the mines ; an increase in its supply has 
very important effects, for the increase will normally be multiplied 
by the market. The supply of other currency, while subject to the 
same influences, is dependent also largely on the will of the banks ; 
while the supply of purchasing power granted by business men in 
the form of book debts is likely to vary with their confidence in the 
business outlook. In a similar way, there is some degree of inde- 
pendence in the various parts of the demand for money. For 
example, the demand for deposit currency has for many years been 
growing much faster than that for notes or gold, while seasonal 
variations in the demand for money fall with unequal pressure on 
the different parts of the supply. This partial independence of the 
different elements composing the total stock of money sets up 
internal strains of a minor character. An instance of some practical 
importance is seen when increasing business activity is accompanied 
by an expansion of credit. In these circumstances the growing 
demand for money of all kinds leads to a withdrawal of gold and 
silver for making larger wage payments, and so reduces the basis 
on which the cheque currency rests and limits its further expansion. 
In normal circumstances the partial independence of these various 
elements of the stock of money is insufficient to cause any divergence 
between the value of the different kinds ; a sovereign, a pound note 
and a cheque for £i have equal purchasing power. In exceptional 
circumstances, however, these values may diverge. When, for 
example, during the Napoleonic wars the Bank of England note was 
made inconvertible and its connexion with gold temporarily broken, 
the value of the note fell below that of the five sovereigns it repre- 
sented ; so, too, as a result of the restrictions on the use of gold. 
Treasury notes have diverged in value from their nominal equiva- 
lent in sterling. Again, during the American crisis of 1907 the value 
of the cheque in the Middle West fell below its nominal value in 
gold, for gold was unobtainable, and the cheque was not universally 
acceptable in wage and similar payments. Yet, again, differences in 
the degree of confidence which the public feel in the various parts 


of the currency may cause a divergence in their value ; such was the 
case in Russia in 191 8 when Imperial rouble notes circulated at one 
value, those issued by the Kerensky Government at a lower level, 
and those issued by the Bolshevik Government at a lower level still. 
It is conceivable that a failure of confidence in the English banks 
might cause the bank-note or the cheque to fall to a discoimt in terms 
of gold. In fact, however, the experience of the present war has 
shown that such an influence is too remote to need considera- 
tion. We conclude therefore that the stock of purchasing power 
is not perfectly homogeneous ; that consequently there arise 
disturbances within the stock which in exceptional circumstances 
may lead to serious divergence in the value of the elements of 
which it is composed ; but that in normal conditions the unit of 
each kind is identical in purchasing power. With this brief dis- 
cussion we may set aside the complications due to the composite 
character of the state of money and henceforth regard this stock 
as homogeneous. 

We may now pass on to consider the main causes on which the 
value of the unit of money depends, defining the imit as the 
sovereign, or one of its substitutes. The question to be considered 
is that of the general causes governing the purchasing power of 
the sovereign, or, what is the same thing, the general level of prices. 
It has already been shown that the value of the unit of money 
depends on the relations of demand and supply. We take the 
demand for money to consist simply of the volume of pajonents, 
present and contingent ; but supply must be given a wider meaning 
than that employed in the discussion of the Quantity theory and, 
for the purposes of the present argument, be taken to include not 
only the volume of currency, but the total stock of purchasing 
power whose nature has just been discussed. StabiHty in the value 
of the sovereign depends, therefore, on a continuous correspondence 
between the volume of money work and the volume of purchasing 
power ; any variation in the one unaccompanied by a similar and 
equivalent variation in the other expresses itself as a change in the 
purchasing power of the sovereign, or what is precisely the same 
thing, a rise or fall in the general level of prices. In actual con- 
ditions the volume of money work varies from causes which are 
largely beyond control, while the volume of purchasing power, so 
far from adapting itself to these variations, is subject to arbitrary 
and independent fluctuations of its own. The practical problem of 
imparting stability to the purchasing power of the sovereign lies, 
therefore, in such a regulation of the stock of purchasing power 
as will eUminate arbitrary variations on the side of supply, and 
will cause the stock to vary in volume in response to changes in 
the volume of payments. 


In order to investigate the principal causes of changes in the 
purchasing power of the sovereign we may conveniently separate 
them into three groups in accordance with the length of the period 
during which they operate. In the first group we include secular 
movements such as the continuous increase which occurs in the 
volume of money work, and persistent changes in the annual 
output of the mines. In the second group we include more 
temporary causes, of which the most important are those operating 
in cycles of nine or ten years : those contained in changes in the 
general level of confidence which, by initiating an increase in the 
volume of purchasing power, introduce a rapid rise in the general 
level of prices, followed during the latter part of the period by an 
equally rapid fall. In the last group we include those transient 
influences which originate in such conditions as seasonal changes in 
the volume of payments, or a temporary ebb or flow of gold. 

The separate influence of these three sets of causes on the 
purchasing power of the sovereign are partly illustrated by a 
diagram, such as that prepared by Sauerbeck, showing the course 
of average prices during the past one hundred years. The effects 
of the persistent causes contained in the first group dominate the 
general trend of the price level, and are shown in red in a hand- 
drawn curve. They are especially marked during the period 
following 1875, when the enormous expansion of production caused 
so great an increase in the volume of payments that, in spite of 
the concurrent growth of the cheque system, the purchasing 
power of the sovereign was persistently raised for twenty years. 
At the end of this period the increased output from the South 
African gold mines reversed this movement and initiated a rise 
of prices which has since been emphasized by conditions of general 
war. Superimposed on this is a second curve, showing rhythmical 
fluctuation of prices about the primary curve, due to cycles of 
alternate activity and depression. Finally, we may suppose the 
influence of the last group of causes to be shown by a third curve 
superimposed on the second and fluctuating closely about it. 
This third curve is, however, not shown on the diagram ; and, 
if it were, it w^ould not fully illustrate the operation of this third 
group of causes ; for their effects on prices are to some extent 
extinguished by the influence of the banking system in counter- 
acting temporary changes of pressure in the foreign demand for 
gold, and in adapting the supply of currency to temporary changes 
in the home demand. These influences must be examined rather 
more fully in the following paragraphs ; but attention will be 
given mainly to the side of supply, inasmuch as the question 
with which we are primarily concerned is the elimination of these 
variations by the regulation of the volume of purchasing power. 


The production of gold is controlled by mine-owners working 
for profit on ordinary business principles ; it depends to a much 
less extent than before on the working of alluvial deposits and to 
a much greater extent on the application of ordinary industrial 
methods in the extraction of the metal from ores of comparatively 
low yield. Accordingly, when the exchange value of the metal 
falls, the amount produced tends to decline ; for example, during 
the period 1913-1918, when the purchasing power of the sovereign 
was falling fast, the world's annual output of gold declined from 
£95 m. to about £83 m., a decrease of some 14 per cent.^^ Con- 
versely, when the exchange value of the sovereign rises, output 
tends to increase. But gold is very durable and the accumulated 
stock is large ; the amount in money uses throughout the world 
being estimated in 1914 at about £1700 m.^^ Changes in the 
annual output initiated by changes in the value of the sovereign 
can, therefore, exert little influence during short periods upon the 
size of this stock ; in other words, during periods of a few years 
there is little response in the total supply of gold to changes in 
the volume of money work. 

When longer periods of time are taken into account, history 
shows that changes in this supply of gold have been still more 
independent of demand, for they have depended primarily on the 
discovery and exhaustion of mines, and improvements in methods 
of production. It is clear, therefore, that the supply of gold, the 
first element in the stock of money, does not adapt itself during 
short periods to changes in the amount of money work, and that 
over long periods it is subject to arbitrary changes of its own 
which are an important cause of variations in the purchasing 
power of the unit of money. 

The second group of influences disturbing the value of the 
sovereign are bound up with changes in the general level of con- 
fidence ; they are those which cause the actual level of prices to 
oscillate rhythmically about the primary curve. A little more 
must be said with regard to the nature of these influences. We 
may begin by repeating a statement which appears to be axiomatic : 
namely, that no change can occur in the value of the sovereign, 
that is to say, in the general level of prices, except through the 
causes governing the supply of purchasing power (or the activity 
with which it is employed) and the volume of money work. If 
that statement is true — and it seems difi&cult to doubt it — ^it 
follows inevitably that the upward movement of prices which 
marks the earlier stages of a business cycle is due to a more 
active use of the stock of purchasing power, or to an increase 
in its volume proportionately greater than the increase in the 
volume of money work which it is substantially certain occurs 


at such times. It is not difficult to see how such an increase 
may occur. 

As a basis of explanation we have the following conditions, 
already noticed, namely : that the total purchasing power in 
the hands of the public consists predominantly of bank deposits, 
notes, and the power to buy granted by business men to their 
customers and recorded in the form of book debts and contracts ; 
that the volume of this purchasing power depends upon the level 
of credit ; and that the level of credit is part of a more general 
condition, the level of confidence. In order to indicate the influence 
of these conditions let us assume a rise in the general level of con- 
fidence in the business outlook; that is to say, an anticipation 
by business men that increased output will be followed by profit- 
able sales. Increased confidence initiates a cumulative increase of 
business activity, and by so doing directly encourages the desire 
to borrow. Contained within it, is increased confidence on the 
part of lenders ; i.e. a rise in the level of credit, which increases 
the willingness to lend or, more broadly, to invest. 

Under the influence of this double stimulus, the greater willing- 
ness to invest and the greater desire to borrow, the supply of pur- 
chasing power is likely to be increased from many sources. A 
portion, at least, of that part of the stock of money which is held as a 
reserve against contingencies (cf . pp. 32-3) and much of that which is 
accumulated on deposit accounts and elsewhere pending a favourable 
opportunity of investment (cf. pp .70-1), is likely to be thrown into 
active circulation ; "... as an immediate result of every boom 
in industry and trade," says Lansburgh,^^ " part of the money 
deposited with the banks is withdrawn and invested in the most 
profitable branches of business." That the same influences lead 
to an expansion of trade credit is suggested by the increase, at 
such times, in the volume of speculative operations and of bills of 
exchange (cf . pp. 270-3) ; while the foreign statistics showing the 
increased number of bills discounted by bankers abroad and the 
tendencies of banking policy in this country both suggest that the 
prevailing confidence encourages banks to expand their loans and 
so add still further to the increase in the volume of purchasing 
power and the consequent rise in the level of prices. 

These considerations bring out two points of significance : 
they show how readily the volume of purchasing power may be 
expanded as a result of a rise in the general level of confidence ; 
and they show that a part, and perhaps a very large part, of this 
expansion takes place in a manner which is quite outside the control 
of the market. There is no central authority which can check the 
active employment of money previously held in reserve, the transfer 
of lodgments from deposit to current account or the expansion of 


trade credits. The banks, however, are able at will to vary the 
volume of the cheque currency by increasing or diminishing their 
loans ; it is therefore with them that the main power must lie of 
correcting the undue expansion of purchasing power during periods 
of rising prosperity. For this reason — the intimate connexion 
between expansions of credit and banking policy — little is said at 
this point with regard to the phenomena of business cycles ; the 
brief outline which we require is given in later chapters in the 
course of a more detailed discussion of the banking system. 

A similar reason makes it convenient to postpone consideration 
of the third group of causes which set up minor fluctuations in the 
value of the sovereign. Some indication of their nature and their 
social cost is given in the following chapter, but they are most 
appropriately examined in connexion with the machinery and 
policy of the banking system. 

The argument of this chapter may now be summarized. It 
has shown that the stock of money is composite and that in conse- 
quence there occur wdthin this stock certain minor disturbances 
which may in exceptional circumstances give rise to divergence 
in value between the elements of which it is composed. Neglect- 
ing these divergencies, however, the value of the unit, i.e. the pur- 
chasing power of the sovereign or its substitute, is determined by 
the relations between the volume of money work and the volume 
of purchasing power. Stability, therefore, can be attained only 
by a continuous adjustment of the one to the other. So far, how- 
ever, from the stock of money adapting itself to changes in demand 
it is subject to arbitrary changes of its own. Being composed 
essentially of gold multiplied by the use of credit into a larger 
supply of purchasing power, its volume varies with the activity 
of the mines, with the general level of confidence and with other 
minor causes. Accordingly, in addition to variations arising on 
the side of demand, the purchasing power of the sovereign is subject 
to persistent changes extending through long periods as a result 
of changes in the profitableness of gold mining ; it is subject to 
more rapid and intense variations owing to alternate expansions 
and contractions of credit, and finally it is subject to transient 
oscillations arising from such influences as a temporary shortage of 
gold or a " lock up " of bank currency. 

In addition to these causes, arbitrary state action has always 
existed as a potential source of disturbance in the value of money. 
In 1913 the monetary system of this country might reasonably 
have been discussed without reference to the possibility of such 
action on the part of the Enghsh Government ; but the incidence 
of the European War has dispelled this with other illusions, and 
raised this cause of disturbance to a position of predominant 


importance for the time being. During the war the supply of 
legal tender money has been increased by some £300 m., and bank 
loans have been more than doubled. This expansion of the money 
stock, accompanied by a decline in the volume of money work, has 
naturally led to a fall in the value of the unit of currency, in terms 
of goods, of some foreign currencies and of gold. The falling 
value of money, in other words, the rising level of prices, has caused 
a transfer of wealth to business men from those whose incomes 
are fixed more or less unalterably by contract and custom ; and 
this transfer has led to social unrest partially expressed in the 
continuous demands for higher levels of money wages. The extent 
and the ramifications of the social disturbance due to the expansion 
of the money stock could not of course have been predicted ; for 
monetary influences have been complicated by the disorganization 
of production, abnormal State control, the disturbed condition of 
foreign countries and the growing aspirations of labour. But the 
general character of these effects are quite in harmony with the 
past experience on which monetary theory is based. The course 
of events since 1914 has given a compressed and vivid account of 
the manner in which the money system operates. It leads not to 
a reversal but to a refinement of economic theory. It may com- 
plicate, but it does not remove, the monetary causes of social dis- 
turbance which were in operation before the war ; and the need for 
their examination is as great as it ever was. Partly for this reason, 
partly because this book is concerned mainly with general theory, 
partly because of the large and growing literature following in the 
train of current changes, no account is given here of the convulsive 
monetary history of the past few years. 



HAVING distinguished three kinds of variation in the 
purchasing power of the sovereign, it remains to consider 
their social importance. It will be worth while to begin 
by stating the reasons which make changes in the value 
of gold more important than similar changes in other commodities. 
This can be followed by a general statement of the manner in 
which the social disturbance due to the first two kinds of variation 
actually arises. And finally some account can be given of the 
less important fluctuations which occur from day to day in the 
Money Market. 

Variations in the value of the unit of iron, or wheat, or other 
commodity, increase the uncertainty of business to those who deal 
in them and so have a local importance of their own. Variations in 
the value of the sovereign have an importance which is enormously 
greater ; not only do they increase the uncertainty of business 
generally, but they distort the normal adjustments of resources 
to needs and set up disturbances of the greatest social importance. 
The reason for this difference is not difi&cult to find. It lies in the 
fact that the sovereign, being the unit in terms of which payments 
are effected, naturally becomes also the unit in which are expressed 
the values of goods both present and future. In consequence of 
this, changes in the value of the sovereign differ from changes in 
the value of ordinary commodities not only in the far wider range 
of their effects, but also in two other respects. 

From the fact that the sovereign is the unit in which the values 
of other things are measured, it follows that its own value cannot 
be stated like that of iron or wheat, by a single figure apparent 
to all. A change in the value of iron is readily shown by a quota- 
tion of its price ; a change in the value of the sovereign can be 
shown only by means of an index number, i.e. a figure showing 
that it will purchase a greater or smaller quantity of a composite 
group of goods selected as representative of all. Such an index 
number will often give ambiguous results, and in any case conveys 
little to the average business man. While, therefore, any change 
such as an increase of supply will, in the case of iron, be immediately 


felt in the market and published abroad by a fall of price, a similar 
variation in the case of the sovereign cannot be readily expressed 
in a single figure. It is consequently not generally recognized, and 
does not cause an immediate and universal change in its value 
in terms of all other goods ; in other words, it will result not in an 
immediate adjustment, but in a slow and irregular fall in the value 
of the sovereign ; that is to say, a slow and irregular rise in general 
prices. There is a second point/ /Possible changes in the value 
of wheat or iron are at least the subject of business discussion ; they 
may in part be foreseen, and so affect the terms of contracts in- 
volving future delivery. But, owing to the natural habit of regard- 
ing the unit of value as invariable, changes in the purchasing power 
of the sovereign are frequently not even contemplated, and if they 
were, the causes on which these changes rest would usually be too 
obscure to enable them to be adequately taken into account in 
contracts involving future payments. These three considerations, 
the variety of causes initiating variations in the purchasing power of 
the sovereign referred to in the last chapter, the impossibility of 
adequately foreseeing these changes, and their imperfect recognition 
by the general public when they are actually occurring, are of 
especial importance in modern conditions where production takes 
time and is based largely on contracts involving future payments. 

In modern conditions the various parties to production bind 
themselves together in a set of contracts which are expressed in 
terms of the sovereign and commonly based on the assumption 
that its purchasing power will remain invariable. A rise or fall in 
the value of the sovereign surreptitiously modifies these contracts 
and so causes a transfer of wealth from one party to another. This 
effect results from the fact that the change could not be foreseen. 
It is reinforced by the further fact that when the change is occurring 
it is only imperfectly realized. Substantially all wage contracts, 
as well as some contracts for the supply of capital and the hire 
of buildings and land, are made for short periods and are conse- 
quently capable of being rapidly modified to meet the changing 
conditions. In fact, however, the imperfect recognition of the 
changing value of the sovereign delays this readjustment ; rates 
of wages, interest and rent are varied too slowly and the transfer 
of wealth continues practically throughout the whole period of the 

The first condition is then that changes in the purchasing 
power of the sovereign modify current contracts and cause a transfer 
of wealth among the producing parties. The social effects of this 
disturbance are most conveniently seen by tracing their influence 
on the action of business men whose function it is to undertake 
the organization and to bear most of the risks of production. 


The business man may for many purposes be conveniently 
regarded as a middleman operating between a set of prices. He 
has before him, on the one hand, the prospective price of some 
product, and on the other, the current prices of the various materials 
and services of which the product is composed. It is his object to 
buy supplies of these elements, combine them into a finished 
product and to draw a profit from the difference between the sum 
of their prices and the price at which he sells the product. He is 
therefore the centre of the set of contracts on which the typical 
productive operation is based. In actual practice he may obtain 
the use of land and buildings on lease ; he is likely to obtain a part 
of his capital against mortgages, debentures or preference shares, 
i.e. by long contracts at a fixed rate of interest ; he will obtain 
his supply of labour on short-wage contracts and his suppUes of 
materials on contracts of varying length. All these contracts are 
expressed in terms of the sovereign which, broadly speaking, is 
regarded by all the parties concerned as fixed in value. In these cir- 
cumstances if the purchasing power of the sovereign begins to fall, 
in other words if prices begin to rise, there begins a transfer of wealth 
to him from property owners, capitalists, wage-earners and, tem- 
porarily perhaps, from those who supply him with raw materials. 
He receives a bounty over and above the return which he antici- 
pated, and his business becomes exceptionably profitable. He 
therefore extends his operations. There is an increased demand 
for labour which finds full employment at rates of wages whose 
nominal value is slowly rising ; an increased demand for bank 
loans at rising nominal rates of interest, and an increased demand 
for raw materials at rapidly rising prices. But even though the 
prices of his raw materials rise more rapidly than the price of his 
finished product, the bounty continues ; for the rate of interest 
on his fixed contracts for capital remains unchanged, the wages 
of labour move upward only slowly, and the new supplies of capital 
from the banks are Ukely to be obtained at rates which do not 
take full account of the falling value of the sovereign. Moreover, 
as already noticed, the additional supply of " capital " obtained 
from the banks is not an addition of raw materials and so on, but 
an increased supply of " command over capital," or purchasing 
power, whose effect is to raise prices further and to increase the 
stimulus to business activity. But this bounty to business men 
is obtained at the expense of other parties, for every shilling paid 
in rent, wages or interest has a lower purchasing power than before. 
The effect of this fall in the value of the sovereign has been, there- 
fore, to distort the price index on which the various parties to 
production have adjusted their relations to one another, thereby 
giving a stimulus to business men, a stimulus which is wholly 


artificial and cannot, as events are now ordered, be permanently 

Opposite effects follow in the converse case when the purchasing 
power of the sovereign is rising. A transfer of wealth sets in from 
business men to property owners, wage-earners and capitalists, 
and continues so long as the readjustment of rates of rent, wages 
and interest is incomplete ; profits decline, business is contracted 
and unemployment increases, these effects again being due to the 
distortion of the price index on which economic adjustments are 

The essential effects of changes in the purchasing power of 
the sovereign appear then to lie in the transfer of wealth which 
affects especially the profits of business and consequently the 
activity of business men in organizing production. Changes in 
one direction stimulate trade and industry ; real rates of wages 
and interest are adversely affected, but labour and capital are fully 
employed ; the exceptional profits of business lead to speculation 
and the growth of speculative undertakings, many of which can 
exist only so long as the stimulus is maintained. Changes in the 
other direction depress trade and ndustry ; real rates of wages 
and interest are favourably affected, but much labour and capital 
is idle ; losses and low profits make business men unduly 
While these seem to be the essential effects of changes in the value 
of the sovereign, their ramifications and their final consummation 
depend largely on the cause to which the change was originally 

A change due to a persistent increase in the output of gold may, 
by affecting the general level of confidence, promote an expansion 
of credit and thus indirectly cause a severe fluctuation of business 
activity ; an instance of this was the effect of the new Californian 
gold in promoting the conditions which led to the crisis of 1855. 
Such a change need not, however, lead directly to a reckless expansion 
of business of this kind ; it may have as its chief social evil a re- 
distribution of wealth which injures wage-earners and people with 
fixed incomes.^ Perhaps the most striking effects of a persistent 
change of this kind are seen in the period following 1875, when the 
output from the mines was insufficient to keep pace with the growing 
volume of business transacted in terms of gold, and the value of 
the sovereign appreciated continuously for twenty years, the general 
level of prices falling from 100 to 64 during that period. The 
rising value of the sovereign, carrying with it a transfer of wealth 
from business men, produced a marked and persistent business 
depression. Profits were low, unemployment was widespread, 
but rates of real wages rose more rapidly than at any time during 
the century. At the end of this period the new supplies of gold 


from South Africa reversed the situation and introduced a series 
of changes in the opposite direction which have continued until 
the outbreak of war. Business profits increased ; rates of interest 
and wages nominally rose, but the rates of real wages seem to have 
been stationary or, perhaps, even to have decUned, a circumstance 
associated with the growing unrest among the working classes 
during recent years. 

It would be unreasonable to expect that any one thing should 
possess in a high degree the properties which adapt it to serve as a 
convenient means of effecting current payments, and also that 
stabihty of value which fits it to serve as a standard in which 
contracts involving future payments may be suitably expressed. 
Gold has been employed for both purposes, and in consequence has 
served neither with any approach to perfection. Possibly it has filled 
the two uses better than any other single thing could have done ; but 
in its use as currency it has been largely displaced by paper, and it 
is evident from the changes in its purchasing power during the 
last hundred years that its employment as a standard leads to 
social evils sufficiently serious to justify a search for a more efiicient 
substitute. It would, of course, be possible to moderate these per- 
sistent changes by exercising control over the mines, and by allowing 
the output to vary not, as now, in accordance with the profitable- 
ness of mining, but in conformity with changes in the money 
and industrial demands for the use of gold. It seems, however, 
that a more effective method would be to abandon gold as the 
standard of value, and to employ some other standard specially 
selected to serve this purpose alone. Such a proposal is now very 
old. Jevons, Marshall and, most recently, Professor Irving Fisher 
have advocated the use, voluntarily or compulsorily, of a standard 
based on an average value of a group of selected commodities. 
However, even the fluid social conditions of the present time, and 
the rapidity with which the structure of society is now being 
modified, do not seem to bring much nearer the possibility of a 
change so dif&cult to comprehend and of so far-reaching a character. 

Changes in the purchasing power of the sovereign due to per- 
sistent changes in the supply of gold introduce disturbances which 
are sufiiciently serious. They are overshadowed, however, by the 
evils of changes which arise from expansions of credit. During 
the course of such an expansion not only does the value of the 
sovereign fall very rapidly, but it provokes an extravagant and 
artificial expansion of business activity which proceeds until its 
contained causes destroy the undue confidence on which it is based, 
and lead, perhaps through a crisis, to falling prices and a business 
depression in which social resources, human and material, are 
disorganized and partly unemployed. The history of the past 


century is full of such fluctuations of business activity, and it is 
unnecessary at the moment to trace their course more fully. The 
point which needs emphasis now is that an expansion of purchasing 
power is an essential condition for the rapid rise of prices during 
the earlier stages of a business cycle, and that this expansion is a 
consequence of a rise in the level of credit. In practice, business 
men, if they were willing to do so, could hardly unite to check 
these effects of expanding credit ; but it would seem to be within 
the power of the banks to take effective action, during periods of 
rising confidence, to restrict the supply of currency granted to 
business men, and so to check the rise of prices on which this 
increasing confidence largely depends. This line of thought sug- 
gests that in existing conditions the most effective remedy for 
expansions of credit is to be found in a modification of the loan 
policy of the banks. 

The short period changes in the value of the sovereign which 
now remain to be considered have their origin mainly in temporary 
changes of pressure on the central gold reserve. We may retain 
the assumption of an effective gold standard and deal with them in 
the light of pre-war conditions. Their influence in post-war 
conditions is indicated later. 

In proceeding to consider the social effects of these variations 
it is convenient to recall the fact that the currency issued on the 
basis of this reserve is supplied by way of loan, and consequently 
that every change in the volume of supply is reflected in the rate 
of interest at which that supply is marketed. The manner in which 
currency is issued does not in any way alter the fact that every 
increase in its supply initiates a fall in the purchasing power of the 
sovereign, i.e. a rise in the level of prices, and that every decrease 
tends, conversely, to bring about a fall of prices. But it makes it 
easier to indicate the social cost of these temporary variations ; for, 
instead of attempting to trace their temporary effects in terms of 
prices, it will be sufficient, and much more simple, to consider them 
in terms of the disturbances they produce on the rate of interest, 
or rather on that particular rate of interest which is paid for the 
use of capital supplied for short periods against biUs of exchange 
and is known as the market rate of discount. 

When the quantity of gold flowing from the mines into the 
London market is persistently increasing the supply of the metal 
available for money use throughout the world, there naturally 
occurs a persistent tendency to an increase in the central gold 
reserve held by the Bank of England. In the normal course of 
events the banks, having larger reserves, would extend their loans, 
and by so doing would multiply the excess in the customary pro- 
portion ; the volume of deposit currency would be increased and 


there would set in a persistent and irregular rise of prices accom- 
panied by the effects which have already been discussed. When 
the increase of gold in the London market is temporary, a similar 
train of events is set in motion, but is, of course, not completely 
carried through. It encourages the banks to supply Command 
over Capital more freely for those uses from which it can readily 
be withdrawn, and so leads to increased supplies in the short loan 
market. This increase of supply, in itself, tends to a fall in the 
discount rate ; but the anticipation of rising prices which it carries 
with it may so quicken demand that the rate actually rises. Con- 
versely when, let us say, a sudden foreign demand for gold causes 
a withdrawal of gold from the Bank of England, its immediate 
effects are seen in a contraction of supply in the short loan market 
and a consequent rise in the discount rate. These effects result 
from what one might call the automatic operation of the banking 
machinery ; they are reinforced by more conscious action taken 
by the Bank of England to maintain the central reserve of gold 
at a customary level. This last point depends on the nature of 
the market machinery and must be looked at rather more closely. 

When a foreign demand leads to an appreciable withdrawal 
of gold from the central reserve, the Bank is Ukely to raise its 
of&cial rate, contract its loans and so reduce the supply of money 
available in the market. As the currency issued by the Bank of 
England forms the main reserves of the other banks, this reduction 
in its amount would in time cause a reduction of their loans, not 
only in the short loan market but throughout the country. The 
ultimate effects of a persistently high Bank rate would, then, be 
seen in a contraction of the supply of money which would raise the 
value of the sovereign in England, i.e. lower the level of prices, 
and so draw in gold from abroad. Its more immediate effects 
would be to raise the market rate of discount, thereby making it 
more profitable than before for foreigners to leave their funds in 
London, in that way checking the outflow of gold and encouraging 
its inflow. 

Let us return now to the original cause of the disturbance, the 
withdrawal of gold. If the cause of this withdrawal had been, let 
us say, an expansion of credit in England which had raised prices 
here above those prevailing elsewhere, and so made gold cheaper 
here than abroad, the outflow of the metal could not be finally 
stopped until this cause had been removed. And this cause could 
not be removed until the volume of purchasing power had been 
contracted, and the contraction had worked out its ultimate effects 
as indicated above in lowering the general level of prices in this 

But the causes of disturbance with which we are concerned are 


temporary ones, such as a withdrawal of gold to meet a transient 
monetary difficulty in a foreign centre, or to pay for heavy importa- 
tions of grain due to a failure of the home harvest. Such causes 
of withdrawal, being temporary, can and should be met by tem- 
porary means ; and are most conveniently met by a temporary 
rise in the market rate of discount which, by encouraging the 
export of securities and by making it more profitable for foreigners 
to hold balances in London, relieves the pressure on the central 
gold reserve. 

The effects of these temporary changes of pressure on the 
central reserve are, therefore, mainly concentrated in the short 
loan market and expressed in the form of fluctuations in the rate 
of discount. It is these fluctuations which we take as an index 
of the social cost of the changes now under consideration. 

The incessant variations in the rate of discount which occur in 
the London Market have their effect on the one side in increasing 
the risks of the banks, the bill brokers and other lenders, and conse- 
quently in increasing the payment which the community is required 
to make them for their services. On the other side, alternations 
of ** dear " and " cheap " money have similar effects on borrowers. 
The risks of merchants are increased, for they have no certainty 
as to the rate at which their bills will be discounted ; when rates 
are low they can profitably extend their operations ; when rates 
are high a part of their business is cut off. Cheap money and 
plentiful supply increase the means at the disposal of the speculator 
and tend to raise prices on the Produce Markets and the Stock 
Exchange. Dear money and short supply compel him to sell his 
holdings of produce or securities and so tend to bring prices down 
again. These alternations have their influence, too, on the issue 
of new securities. Company promoters wait for conditions in 
which there are low rates and a plentiful supply of funds available 
for speculative buyers to take up the securities they are selling ; 
they tend therefore to postpone their issues until these favourable 
conditions occur, and may even create the conditions required, by 
arranging on their own account for an import of gold. 

These disturbances, due mainly to temporary variations in 
the available supply of gold, though appreciable, are evidently 
of quite secondary importance in comparison with those which 
were previously discussed. It is not suggested that all the fluctua- 
tions in the rate of discount are due to this cause, but they are 
greatly increased by the extreme sensitiveness of the market to 
even small changes in the gold reserve of the Bank of England. 
Thij sensitiveness is due in a great measure to the small size of 
the central gold reserve in relation to the vast liabilities of the 
market ; a partial remedy for these disturbances is therefore an 


increase of this reserve. A comparatively small addition to the 
average level of the central stock of gold would enable the Bank of 
England to absorb minor fluctuations and would relieve it from 
the necessity of continually initiating, by means of changes in the 
of&cial rate, reactions which affect the market rate of discount, 
and so constitute a source of frequent though minor disturbances in 
the business of the Money Market. 

The need for an increase in the central reserve has long been 
admitted. The practical application of a remedy is, however, now 
bound up with the need to provide an adequate backing of gold 
for the Treasury notes issued since the outbreak of war. The 
questioii is dealt with by the Committee on Currency and Foreign 
Exchanges after the War, who recommended in 1918 that the 
normal minimum amount of the central gold reserve should be 
provisionally fixed at £150 m.,20 a level which has now been attained. 


THE manufacture of currency and the transport of capital 
are so closely bound up together that some account of 
the theory of money has been essential. The theory has 
been dealt with, however, only in outline, as the subject is 
subordinate to the main considerations of this book. It may now 
be summarized, partly in order to give greater unity to the argu- 
ment, partly in order to bring into prominence those conclusions 
which bear most closely upon the work done by the market in the 
transport of capital. 

The large volume of payments which people need to make 
requires that their resources should be marketable and so accept- 
able as a means of payment. In fact, however, land, houses and 
other property possess this quality only in a limited degree ; hence 
it becomes convenient to accumulate a supply of some thing 
specially chosen for its perfect marketability, to hold this as a 
stock and to employ it solely as a means of effecting payments. 
The volume of payments, present and prospective, determines 
therefore the fraction of their total resources which people devote 
to this particular use ; the quantity of resources which each person 
holds forms his individual demand for money, and the aggregate 
of these individual amounts constitutes the total demand for 
money. The nature of this demand requires that the stock of 
money produced in response to it shall have two main properties. 
In the first place, owing to the variety in the kinds of payments, 
the supply must be differentiated into various forms, each of which 
is specially adapted to the particular kind of payment it is required 
to carry through. The market responds very effectively to this 
part of the demand. It supplies currency in very convenient 
forms, and by so doing effects a marked economy in the cost and 
risk of making payments. The deposit currency produced by the 
banks is not only peculiarly adapted to carry through payments at 
a distance, but contributes materially, in a manner to be con- 
sidered more fully later (pp. 144-5), to lowering the cost at which 
capital is transferred cheaply and rapidly from one point to 

But the use of money as a means of buying goods naturally 



leads to its becoming the general measure of value and conse- 
quently to its being employed, not only in making present payments, 
but also as the unit in which undertakings to make future payments 
are expressed. If these undertakings or promises are to be carried 
through without disturbance, the unit of money must possess a 
second quality ; it must be free from arbitrary changes in value. 
It is in connexion with this second consideration that the theory 
of money possesses such great importance and gives rise to such 
great difficulties. 

Hitherto it has been implied that *' stability of value " is the 
ideal condition which the unit of money should attain. This is 
not necessarily true. It is evident that when two parties enter 
into a mutual undertaking involving a future payment, one will be 
injured and one will be benefited if the value of the unit in which 
the contract is expressed varies in a manner which is not perfectly 
foreseen by both. It follows that stability in the value of the unit 
would prevent this injury from arising. But it does not follow that 
this would be the ideal condition ; for it is quite conceivable that the 
unit might change in value in a manner which, though it did injury 
to one party, yet produced a transfer of wealth which was on the 
whole socially desirable. It would, however, be far beyond the 
need of the present argument to consider the nature and extent 
of the duty which could properly be assigned to the standard of 
value in reforming the social organization. It is sufficient to adopt 
the approximate ideal of stability of value, even though this term, 
itself, cannot be given any very precise meaning. 

The means by which this stabihty could be attained lay, it was 
noticed, in the continuous adjustment of the volume of purchasing 
power to the volume of money work, and were considered mainly 
from the point of view of Supply. In actual conditions, it was 
seen. Supply not only failed to adjust itself to Demand, but was 
subject to arbitrary variations of its own. These variations were 
classified into three groups corresponding to the length of the period 
during which the disturbing cause was in operation. 

The first cause, originating in changes in the profitableness of 
gold mining, gives rise to persistent appreciation or depression of 
the sovereign extending over periods sometimes so long as twenty 
years, accompanied by a persistent transfer of wealth from one class 
to another, and possibly provoking an expansion of credit. The 
remedy lies in assuming control over the output of gold with the 
deliberate object of regulating the value of the sovereign or in 
abandoning gold as the standard of value in favour of some com- 
posite standard specially designed to ensure stabihty. 

The second set of causes, originating mainly in changes in the 
general level of confidence, gives rise to a more speedy depreciation 


in the value of the sovereign. They introduce a rapid transfer of 
wealth which, acting as a bounty to business men, stimulates business 
and leads to reckless trading and investment. But these conditions, 
artificially provoked, carry with them causes which lead to a de- 
struction of confidence, and there follow, possibly a crisis, certainly 
a depression, with widespread and prolonged unemployment of both 
capital and labour. So long as the present standard of value was 
retained, the remedy in this case could, it appeared, lie only in 
suitable action on the part of those who supply the additional 
quantity of purchasing power which accompanies the expansion of 
credit. In practice, it was probably to be found in a different loan 
policy on the part of the banks. 

The final group of causes consists mainly of the very varied 
and numerous influences which lead to temporary variations in the 
central stock of gold and thence to partial and transient changes 
in the value of the sovereign. The disturbances which they 
introduce were seen to be of a quite minor character ; a partial 
remedy lies in such an increase of the central reserve as would 
make the market less sensitive to small changes in its amount. 

In dealing with the operation of the banking system (pp. 161-2), 
it will be argued that the practical policy adopted by the Bank of 
England for the protection of the central reserve may be expressed 
as a policy designed to eliminate fluctuations in the value of the 
sovereign. It is worth while comparing this policy with the 
action of associations of producers in regulating the price of in- 
dividual commodities, with the old sliding scale of corn duties and 
with the introduction of import duties to check dumping ; each of 
which is a deliberate attempt to lessen the disturbing influence 
on the organization of production of fluctuations in the price of 
some commodity. For this comparison shows that the deliberate 
regulation of supply by a centralized banking system, with the 
object of reducing fluctuations in the value of the unit of currency, 
is not a unique economic phenomenon ; it is only an application 
to a specially important case of the general rule that fluctuations 
in the value of individual commodities are productive of social 
disturbance and that some of the causes of these disturbances may 
be eliminated by unified action, to the general social advantage. 

The departure from an effective gold standard during the course 
of the war has not freed the value of the unit of money from in- 
stability arising from secular movements, from changes in the 
level of credit or from transient fluctuations ; it has added other 
sources of instability and increased the social importance of their 

Since 1914 a diminished production of goods and an expansion 
of substitutes for gold have caused the purchasing power of the 


unit of gold to fall to about half of its pre-war level throughout 
the world, and the same causes, operating more strongly, have 
reduced the purchasing power of the unit of currency in many 
countries below that of the gold to which it is nominally a title. 
In the United Kingdom, Treasury notes and certificates have been 
created to the amount of some £350 m., and bank deposits subject 
to cheque have probably been multiplied about two and a half 
times. This currency is convertible, directly or indirectly, into 
gold ; but not into gold which can be effectively employed for 
purposes of industry or international payments. Being in excess 
of the amount required to carry through the volume of payments 
at gold prices, the purchasing power of each unit is depressed, and 
is equivalent, in the autumn of 1920, to less than three-quarters of 
that of the gold it represents. The connexion between the internal 
•tock of currency and the external gold market being broken almost 
universally, the adjustment of the price level at home to the price 
levels of foreign countries, normally effected by the automatic ebb 
and flow of gold from and to the money stock, has ceased to operate ; 
and the volume of the home currency, no longer automatically 
regulated by these variations in the reserves on which it is based, 
is now subject to arbitrary control, partly through the Treasury 
policy governing the issue of notes, partly by means of the Bank 
rate and partly by way of collective action on the part of the Joint - 
Stock banks. 

In consequence of these conditions, and of their international 
setting, the value of the unit of currency has become very unstable 
and the effects of this instability very serious. The increasing 
production of goods, the declining output of gold from the mines 
and similar persistent causes are slowly changing the value of the 
unit of gold throughout the world. Such changes are unimportant 
only in comparison with influences more rapid in their opera- 
tion. Working in conjunction with other causes, the policy of 
cautiously restricting the volume of the home currency initiated in 
the spring of 1920 a rise in the value of the unit of currency — ^in 
other words, a fall in the level of prices ; and this tendency has 
been powerfully reinforced by a decline in business confidence. 
Declining confidence in the prospect of effecting profitable sales 
works, on the one hand, to reduce productivity ; for in such cir- 
cumstances merchants postpone orders, manufacturers fear to 
produce for stock and goods are released for consumption by 
speculative holders ; and the growing depression in each industry 
is a cause of growing depression in all others. But, on the other 
hand, it works even more strongly to reduce the amount of effective 
purchasing power : there is a great contraction in the volume of 
promises to pay created by merchants' orders to manufacturers ; 


sooner or later the pressure on the banks for new loans declines ; 
and currency, hitherto actively employed, is withdrawn into 
reserves to meet contingencies, or accumulated pending more 
favourable opportunities for investment. The net effect is to 
reinforce the initial rise in the value of the unit of currency, and 
to accentuate business depression ; working cumulatively these 
various influences seem, towards the end of 1920, to be depressing 
general prices well below the level which may be termed normal 
to the general circumstances, and are causing severe social disturb- 
ance in the form of business uncertainty and extensive unemploy- 
ment of capital and labour. 

Superimposed on these disturbances are those due to minor 
and temporary causes of instability. The lack of connexion 
between the internal currency and the external gold market allows 
the value of the unit of money to fluctuate widely in terms of foreign 
currencies, and so adds greatly to the risks of international trade. 
At the same time the exigencies of Government finance set up 
incessant fluctuations in the supply of Command over Capital in 
the Short Loan market. Supply is made very variable by the 
alternate withdrawal and release of money in order to make im- 
mense interest payments ; and, above all, by the necessity for the 
Bank of England to expand its loans sometimes as much as £50 m. 
in a single week, in order to enable the State to repay maturing 
debt which cannot be renewed from the general resources of the 
market. These fluctuations in Supply, by causing wide variations 
in market rates, substantially increase the risks of business in the 
manner already described ; but the disturbances which they 
introduce are still of minor importance in comparison with those 
due to the more far-reaching influences simultaneously in 



THE second main service of the Money Market — ^that with 
which this book is principally concerned — ^lies in the 
transport of capital ; its importance is to be measured 
by its effects in facilitating the movement of capital into 
those uses in which it can be most effectively employed. But 
before proceeding to deal with the main question of the work 
done by the market, it is necessary to distinguish more clearly 
the nature of the supply of free capital, or the flow of investment, 
which the market transfers from one party to another as a railway 
transports material goods from one place to another. 

As already noticed, each party to production, by virtue of the 
service he contributes, obtains a title to a fraction of the total 
national output, a fraction whose size is measured by the market 
value of his service. This title, converted by the use of a stock of 
money into an effective means of making payments, gives him a 
control over a defined value of social resources in general. It enables 
liim to satisfy his present wants by consuming ; that is, to draw 
from society's workshops things which yield up their satisfactions 
immediately. And it enables him to provide for his future wants 
by postponing consumption, or waiting ; that is, either to direct 
the application of social resources to the production of things 
which yield up their satisfactions in the future, or to transfer to 
other parties, in exchange for a payment of interest, the control 
over resources which he does not himself wish to exercise. It is 
this distribution of resources between present and future uses 
which must first be examined. It has two aspects : first, the move- 
ment of money, which gives rise to the phenomena of the Money 
Market ; secondly, the movement of the underlying social resources 
which the money movement controls. The former aspect is more 
appropriate in considering the matter from the point of view of 
the individual ; the latter is more suitable in dealing with the 
subject from the point of view of society as a whole. 

Let us consider the distribution effected by a typical business 


man of his gross income, using this term to include the return 
which he obtains as entrepreneur for his personal services, and the 
return which he obtains as capitalist from the capital he employs, 
without making any reduction for maintenance either of his own 
energies or of his capital stock. The main influence determining 
the extent to which he will postpone consumption, the amount of 
Waiting he will undertake, will naturally be the size of his income. 
And given the size of his income, the second influence determining 
the volume of Waiting he supplies will be his choice between present 
and future satisfactions. The general consideration by which he 
will be governed will be that of distributing his income among 
all the uses open to him in such a way as to maximize the utility 
which it yields him. But as each particular want is satiable, this 
is equivalent to saying that he will carry his expenditure in each 
direction up to that point or margin, at which another sovereign 
would yield more utility if employed in some other use ; and this, 
again, implies that he will maximize the utility of his income by 
distributing it in such a way that at the margin in each direction 
a sovereign will yield him the same return. If we now divide these 
various uses into two groups, the one yielding present, the other 
yielding future satisfactions and consider how the one is balanced 
against the other we have the influences governing the volume of 
Waiting arising from any given income. 

The relative importance of present and future goods will, of 
course, vary with the character and circumstances of each individual ; 
but in each case as income is taken from uses yielding present 
satisfactions and devoted to uses yielding future satisfactions, the 
urgency of present needs increases and the urgency of future needs 
declines; and, conversely, as more income is expended on goods 
satisf57ing present wants, their yield of utiUty declines and the need 
to provide goods for the future becomes of increasing importance. 
By this process of balancing, an equilibrium will be attained which 
represents the attitude of the individual towards his present and 
future needs. At this equilibrium the yield from the pound which 
he thinks it just, and only just, worth while to save has to him the 
same importance as that of the pound which he thinks it just, and 
only just, worth while to spend on immediate consumption in any 
particular direction. 

These two considerations, then, the amount of his income, and 
his choice between present and future satisfactions, determine 
the volume of the money stream which he directs (annually) into 
uses which meet future needs ; the sum of these individual streams 
forms the aggregate (annual) money flow controlling those surplus 
energies of society which may be devoted to maintaining and 
adding to its accumulated wealth. This stream is not, however, 


the same thing as the annual flow of investment which needs to be 
identified ; several limitations are necessary. 

lii the first place, some clearer distinction is necessary between 
the things which yield their satisfactions in the present and those 
which yield them in the future. These two groups of things have, 
as it were, nuclei but no boundaries ; in practice they form a 
continuous series, the one merging imperceptibly into the other. 
The service of a barber is consumed as it is produced ; resources 
in the form of clothing constitute a stock of services yielding their 
satisfactions only during a period of time ; those in the form of raw 
materials and industrial plant yield their satisfactions more re- 
motely still ; while the stock of services in buildings and similar 
durable goods are yielded only in the course of long periods of 
time. The line of division in this series must be drawn with refer- 
ence to the purpose in hand. The present purpose is to distinguish 
the stream of resources devoted to use as capital, using the term 
'* capital " in the ordinary business sense to include all those 
things (other than land) which are employed for the purpose of 
earning that part of income which is commonly reckoned in terms 
of money. In considering the distribution of income between the 
present and the future, therefore, we may, for present purposes, 
reckon that an individual " consumes " in so far as he exercises 
his control over resources to obtain food, clothing, furniture and 
other things intended for personal, as distinct from business uses ; 
and that he postpones consumption, or waits, to the extent that he 
exercises this control to increase his " capital," either by directing 
resources into his own business or transferring them to other 
parties in exchange for a rate of interest. 

The flow of resources directed into these latter uses forms the 
stream of Waiting proceeding from each individual ; but it does not 
correspond, at any rate during short periods, to the stream of indi- 
vidual investment. In order to bring out this point clearly, 
let us return to the case of a typical business man. His capital 
consists of resources invested in various special forms : a stock 
of money which facilitates his transactions ; a stock of raw 
materials to be embodied in his saleable products ; a stock of 
machinery and other plant which assists him in their manufacture, 
and so on. Suppose that in the course of the year he saves and 
accumulates a stock of money in excess of that which he needs to 
carry out his business transactions. In one sense he is investing, 
in another sense he is not. Without investigating the niceties 
of this question, we must reckon that when he acts in this way he 
adds to his wealth, but not to his capital ; that he waits but does not 
invest ; for otherwise we lose sight of the great difference between 
the social effect of accumulating control over resources and that of 


emplo3dng that control to set resources in motion. This dis- 
tinction between Waiting and Investment is obvious enough ; but 
it is of considerable importance and will be taken up again a little 

Allowance being made for duplication, the sum of these money 
streams proceeding from individuals during the course of the year 
forms what we may call thfe aggregate money stream of individual 
investment. It constitutes the annual flow of Command over 
Capital and controls that part of the productive capacity of the 
country which is devoted by individuals to maintain and add to 
their individual stocks of capital. 

A part of this stream is applied directly by its owners in replac- 
ing and increasing the equipment of their businesses ; the remainder 
forms the supply of " capital," which is transferred to other parties 
by the machinery of the market. It must not be overlooked that 
this remainder is in appearance multiplied by being passed, in 
many cases, through the hands of several intermediaries ; as, for 
example, that which is lent by the public to the banks, by the 
banks to the bill brokers and by bill brokers to merchants ; but 
this consideration does not affect the substance of the argument. 

That part of the stream which is transferred in this way to other 
parties is employed in a great measure in the maintenance and 
extension of business enterprise at home and abroad. But it is 
not all so employed ; for among the borrowers in the market are 
many who bid for the use of resources for the purpose of immediate 
consumption. Resources transferred to the control of spend- 
thrifts. Governments, Municipalities and other parties at home, 
who employ them in consumption, are recorded as debts, which 
constitute capital from the point of view of the individual investor 
but not from that of society as a whole. 

This consideration leads to a distinction between the aggregate 
stream of individual investment and the stream of social invest- 
ment. The latter is obviously the smaller of the two ; it represents 
the resources annually applied to maintain and increase the stock 
of capital of the community regarded as a whole, that part devoted 
to increasing this stock constituting the stream of net social 

We have then three streams of money payments : first, the 
aggregate stream of individual investment, representing the whole 
of the resources annually applied by individuals to maintain and 
extend what from their point of view is capital ; secondly, that 
fraction of this stream which represents resources transferred, by 
the agency of the market, to the control of other parties ; and 
thirdly, that part of the stream which represents the fraction of 
the productive capacity of the country annually applied to increase 


the stock of capital of the community as a whole. A little must be 
said with regard to the size of these streams, the regularity of their 
flow and the work done by the market in facilitating and directing 
the movement of the particular stream passing through its hands. 

First, as to the size of these streams. " The flow of investment 
of resources for future needs,*' says Dr. Marshall,2i "consists of 
two streams. The smaller consists of new additions to the accumu- 
lated stock : the larger merely replaces that which is destroyed ; 
whether by immediate consumption, as in the case of raw material, 
fuel, etc. ; by wear and tear, as in that of railway irons ; by the 
lapse of time, as in that of a thatched roof or a trade directory ; 
or by all these combined. The annual flow of this second stream 
is probably not less than a quarter of the total stock of capital, 
even in a country in which the prevailing forms of capital are as 
durable as in England." The size of the former stream in 1914 
was probably in the neighbourhood of £350 m. per annum. The 
size of the latter is at first sight astonishingly large ; but its magnitude 
is less surprising when it is remembered how large a part of the 
capital employed in industry, and especially in trade, consists of 
coal, metals, textiles and so on, in the various stages of manu- 
facture through which they move in their passage to the consumer. 
The large proportion of resources annually devoted to replacements 
evidently does much to explain the great adaptability of industry 
and trade to the constant changes of demand which it is called 
upon to face. 

Inasmuch as the stream of money payments into investment 
uses involves a corresponding movement of the social resources 
which it controls, it is evident that marked irregularities in this 
stream may be a source of important social disturbance. Mr. 
C. K. Hobson's estimates 22 of the export of capital show that the 
volume of foreign investment varies widely from year to year, but 
little or nothing is known statistically of changes in the annual 
volume of home investment. Nevertheless there are certain general 
considerations bearing on the matter which may be noticed. 

The primary influences affecting the annual volume of the 
stream of investment are evidently those which govern the power 
and the will to save ; those due, on the one hand, to growing 
productive capacity, variations in the bounty of nature and in 
foreign demand, trade disputes and so on ; and, on the other, to 
modifications of outlook leading to habits of thrift or extravagance. 
Such influences, acting through the volume of Waiting upon the 
stream of investment, cause a shifting of resources to or from con- 
structional and exporting industries from or to industries which 
minister to present needs. It would be of some interest to consider 
how far these influences are sufficiently powerful and rapid in their 


operation to strain the adaptability of the industrial organization 
and to form a cause of social disturbance ; but the matter is too 
large to be dealt with here. 

We may pass on, then, to consider the nature of the disturbances 
which arise from a secondary cause ; namely, differences in the rates 
at which waiting and investment proceed. 

In modern conditions some people who wait, or save, apply 
their savings as they accrue to the repayment of bank loans or 
other debts, to the expansion of their businesses and to similar 
uses ; in such cases saving and investing proceeds concurrently 
and no difi&culty arises. But other people act differently ; they 
may save continuously, but they invest only after a period of 
accumulation when a favourable opportunity occurs. When they 
act in this way, they withdraw currency from active circulation, 
mainly by accumulating, at their bankers, lodgments which would 
otherwise be employed as a means of making payments — as orders 
for the production of goods. The total volume of bank lodgments 
remains unaltered, for the banks are not affected by such transfers ; 
but lodgments are shifted from people in general and heaped up on 
the accounts of particular individuals ; in effect, money is being 
hoarded. As a result of this action, a part of the cheque currency 
by which social resources are controlled is withheld from active 
employment, and two consequences follow. The immediate effect 
is that, in consequence of fewer purchases, of a smaller effective 
demand for goods, production slows down. A second effect is a 
general fall in prices, which tends to proceed until the diminished 
quantity of money in active circulation again controls and sets in 
motion the whole supply of social resources. It seems clear that 
this latter compensatory effect must proceed more slowly than 
the former and that in the interval during which it is proceeding 
social resources are imperfectly employed. In other words, in 
spite of the banking system, variations in the interval between 
saving and investing are, or may be, causes of fluctuation in the 
employment of capital and labour. 

This conclusion would be of no importance if the actions of 
investors were independent of one another ; in that case, the 
absorption of money by some individuals would be set off by the 
release of money by others ; a part of the money stock would be 
out of action, but this amount would be tolerably constant and 
saving and investment would proceed concurrently. But such an 
assumption does not correspond to the facts ; for investors are 
moved largely by common causes. They are affected alike by 
variations in the costs associated with Waiting : that is to say, 
by changes in the facilities for marketing their capital ; and above 
all by changes in the current estimates of risk, or more broadly, 



in the general business outlook. Such changes, therefore, are a 
cause of variations in the money stream of investment and of 
disturbance in the resources which that stream controls. 

Goschen 23 drew attention to the powerful influence of the 
rapidly developing Trust and Finance companies during the 
'6o's in directing capital from home to foreign investment ; that 
is to say, from industries which supply capital goods for home use 
to exporting industries which supply the needs of other countries. 
Booms in rubber planting, gold production and similar speculative 
undertakings form more recent instances of the manner in which 
changes in a local business outlook affect the stream of investment 
into particular industries and encourage wide fluctuations in their 

A more important and more interesting question is the manner 
in which the money stream of investment, by varying under the 
influence of changes in the general level of confidence, contributes 
to the intensity of business cycles. An improved business outlook, 
accompanied by rising confidence, increases the demand of business 
men for Command over Capital ; for it urges them to borrow in 
order to exploit the more favourable opportunities for profit. At 
the same time, it increases supply ; for it reduces the investor's 
estimates of risk and opens up many new opportunities for the 
profitable employment of his capital. In such circumstances it 
is hardly possible to doubt that the money stream of investment 
proceeds even faster than the rate of saving, and that its change 
of rate produces the twofold effect already described. 

It increases the activity of the constructional and other in- 
dustries which give effect to social investment and it throws addi- 
tional supplies of money into active circulation, thereby encouraging 
a rise of prices and reinforcing the rising level of confidence which 
is the imrrediate cause of growing business activity. Conversely, 
low or decUning confidence in the business outlook is emphasized 
by its influence on the action of the investor. The rate of invest- 
ment lags behind the rate of saving ; money is thereby withdra\\Ti 
from active circulation ; and a fall in the effective demand for 
goods, accompanied by declining prices, yields its special contribu- 
tion to the disorganization of the relations between producers 
and consumers which marks a period of depression. 

The immediate conclusion, then, is this. In the long run 
the stream of waiting, or saving, is identical with the money stream 
of investment ; and changes in the volume of the one tend to 
produce corresponding changes in the volume of the other. Such 
changes cause a diversion of social resources ; only when they are 
rapid, however, are they likely to produce any social disturbance. 
But the money stream of investment varies also, locally or generally, 


with changes in faciUties for marketing and in estimates of business 
risks. General changes of this kind contribute to the social dis- 
turbance produced by business cycles ; partly by increasing the 
rapidity with which resources are diverted to or from the pro- 
duction of capital goods ; partly by adding to the stock of active 
money when confidence is high and prices are rising, and taking 
from it when confidence is low and prices are falling. 

The money stream of investment with which we have just been 
dealing includes that part which is transferred to other parties by 
the agency of the Money Market. In a final chapter something will 
be said with regard to the comparative size of this latter stream ; at 
the moment we are concerned with the work done by the market in 
facilitating and directing its movement. That work must be judged 
by its effects in enabling capital to move rapidly and economically to 
the points at which it yields the highest return. It lies partly on 
the side of Supply, partly on the side of Demand ; on the one hand 
it lowers the supply price of capital ; on the other it assists in the 
formulation of demand. In the following chapters, therefore, the 
composite supply price of capital is broken up into its three elements, 
the prices of pure waiting, of risk-bearing and of marketing, with a 
view to considering the work done by the market in reducing their 
amount ; next, some account is given of the assistance provided by 
the market in the formulation of demand ; finally, each of the 
individual agencies composing the market is briefly reviewed with 
the object of bringing out the characteristic features of its work in 
promoting the distribution of capital in accordance with the social 





THE many forms of humati exertion put forth in pro- 
duction are separable into two kinds — Working and 
Waiting. There seems to be no fundamental difference 
of nature between the two ; for the qualities of character 
required in some parts of business management are closely similar 
to those exercised in saving. The distinction must be justified less 
by the nature of the exertion put forth than by the nature of the 
product or service to which each gives rise. 

The term Working conveys a clear idea to the mind largely 
by its very ambiguity in implying not only the cost, i.e. the exertion 
which it involves, but also the corresponding service, i.e. the 
work done as the result of that exertion. The term Waiting, on 
the other hand, leaves only a shadowy impression on the mind. 
This seems to be due partly to the fact that the term refers only to 
the cost, i.e. the exertion involved, and does not suggest the 
corresponding service, the supply of Capital ; and partly to the 
fact that this service is itself somewhat obscure. It will be worth 
while to define the nature of Waiting rather more exactly than has 
yet been done in order to bring out its social significance, i.e. the cost 
which it involves and the social economies to which it gives rise. 

As a preHminary we may define Waiting simply as postponing 
consumption ; or, with the object of indicating both cost and 
service, as abstaining from the use or enjoyment of some thing of value 
in the present in order to obtain its use or enjoyment in the future. 

In this definition the cost of Waiting is implied in the post- 
ponement ; while the economic service of Waiting appears in 
the effect of the postponement, namely, in some thing of value or, 
more generally, some quantity of resources, being preserved from 
consumption and consequently made available for use. 

As, however, the Money Market deals in terms not of things 
themselves but of their common money measure, it is convenient 
to express the service or product of Waiting in those terms, so 
that it becomes a measurable thing of two dimensions, a quantity 



of value X a period of time ; £500 supplied for one year being 
regarded, generally speaking, as equivalent to £100 supplied for 
five years. Waiting, then, liberates a quantity of value for a period 
of time ; it makes available for social use a control over social 
resources — a quantity of what strictly should be called " command 
over capital," but is more generally known as " free capital " or 
simply " capital." Inasmuch as exertion is needed for its pro- 
duction, the supply of capital is limited ; inasmuch as it may be 
employed to effect real social economies it is in demand ; accord- 
ingly the use of capital has a value and may be marketed at a price 
known as the net rate of interest. 

The costs of Waiting consist in all the exertions required to 
give up certain enjoyments in the present in exchange for the 
prospect of certain other enjoyments in the future. These exertions 
vary greatly with circumstances, but may often be more severe 
than those of Working ; they comprise not only the exercise of 
considerable imagination in order to recognize the needs of a 
distant future and to balance them against the more vividly pre- 
sented demands of the present, but also the continuous self-control 
required to give effect to this recognition. When a workman is 
saving a fraction of his wages, the reality of his exertion is very 
apparent. At the opposite extreme of the income scale, when the 
heir to £5000 a year abstains from consuming his capital, his Wait- 
ing will always involve the exercise of some imagination and self- 
control to set bounds to his expenditure and save him from the fate 
of the spendthrift ; but although this Waiting will be on a vastly 
larger scale, the total exertion he puts forth may well be much less 
than that of the workman. 

If these two parties invest their capital, the money reward, 
i.e. the interest, received in the two cases will obviously be in pro- 
portion not to the exertion put forth but to the quantity of Waiting 
supplied. It follows that there is frequently a wide disproportion 
between effort and reward ; the rich wait with ease, the poor with 
great difficulty ; and each is paid the same price for each unit of 
capital supplied. If justice requires that material reward shall be 
proportioned to exertion the present method of payment is evidently 
unjust. It must be noticed, however, that Waiting is paid for on 
just the same principle as is Working and that, in this respect, 
the two stand or fall together. The man of great natural endow- 
ments is paid out of proportion to the exertions involved in his 
Working — the leading tenor gets many times the salary of the 
stoutest voice in the chorus — just as the man who inherits great 
wealth gets paid out of proportion to the efforts involved in his 
Waiting. Material rewards are paid by society not in proportion 
to efforts or worthiness but in proportion to the value of services 


rendered ; a system whose defence rests less on its immediate 
justice in individual cases than on its general effectiveness in calling 
forth appropriate quantities of the various kinds of service which 
society requires to satisfy its multitudinous needs. 

The market, then, lays stress not on cost, but on supply ; not 
on postponement, but on the result of postponement, the capital 
thereby made available for use. The important question is there- 
fore to distinguish the nature of the economies which are produced 
by capital and by virtue of which its use commands a price on the 

As we have seen. Waiting, the postponement of consumption, 
places at the disposal of society a quantity of capital by means 
of which the party employing it obtains a control over a quantity 
of resources applicable to any use he chooses. For this capital 
there is a twofold demand corresponding to two distinct kinds of 
uses to which it is applied : first, it enables goods to be " carried " 
from an earlier to a later point of time when they may possess a 
higher value from their ability to satisfy a more urgent need. This 
additional value, one of the sources from which interest is paid, is 
the measure of an economic benefit or service arising from what, 
for the purposes of this chapter, may be called the Consumption 
demand for Waiting, or Capital. In the second place, it may be 
employed in a manner which adds to the efficiency of human effort 
and consequently yields a surplus, a net addition to its own amount. 
This addition of value, the second source from which interest is 
paid, is the measure of a second economic benefit from which arises 
what, for present purposes, may be called the Production demand 
for Waiting. The nature of this double economy which forms the 
source of interest must be considered more fully. 

The Consumption Demand 

The Consumption demand for Waiting calls forth a service 
which is closely analogous to that involved in a trading operation. 
The trader carries a thing of value from some point in space where 
it is relatively little needed to some other point where the need 
for it is more urgent ; and he draws his profit from the additional 
value which this thing acquires as a result of its transfer to the 
latter place. Similarly a person who waits enables some thing of 
value to be carried from the present, a point of time in which it 
satisfies a relatively small need, to some point of time in the future 
when it is likely to satisfy a greater need ; and he draws interest, 
or its equivalent, from the additional value which the thing acquires 
as a result of its transfer to the later point of time. The one carries 
through space, the other through time ; each increases the utility 


of the thing carried by transferring it to a point where it is more 
urgently needed ; and each draws his reward from this increase of 

A primitive instance of Waiting for these purposes is given by 
the squirrel who stores nuts for winter food. He is concerned only 
to carry a quantity of food from a time of plenty to a time of ex- 
pected scarcity ; and he draws an equivalent of interest in the 
increased utility of the food at the later date, that is to say, from 
its ability to satisfy a more urgent need. In business conditions 
these operations are carried out in terms of money, and the corre- 
sponding case becomes that of the thrifty person who saves, say, 
£1000 in order to provide for the needs of his old age. If he simply 
stores this money in a stocking, he will, if he has estimated wisely, 
obtain a considerable reward for his Waiting from the increased 
utility which the £1000 yields him at the later date. This reward 
is essentially interest, although it is not paid by another party and 
is not expressed in terms of money. 

The capital resulting from Waiting is, of course, not necessarily 
used by those who waited and produced it, as in the simple instances 
just quoted ; it may be transferred to others through the agency of 
the Money Market. The first and most obvious part of the con- 
sumption demand for capital expressed in the market is that arising 
from those who wish to consume now instead of later. They feel 
their present needs to be more urgent than those of the future ; 
they desire to anticipate, i.e. to exchange the future for the present, 
and they do so by obtaining the use of capital from those who wait, 
i.e. who exchange the present for the future. Governments who 
borrow through the agency of the securities markets for such pur- 
poses as war, and spendthrifts who borrow on mortgage through the 
agency of solicitors in order to enjoy now instead of later obtain a 
considerable, and at times a very large share, of the annual supply 
of free capital. 

Resources so applied are destroyed ; they add nothing to the 
capital stock of the community regarded as a whole. This does 
not mean, of course, that the Waiting which freed those resources 
for social use has been fruitless. Apart from the advantage gained 
by those who waited, the capital they supplied served a purpose by 
enabling others to transfer a power to consume from a time of less 
to a time of more urgent need, thereby making a net gain of utility, 
a part of which was paid over in the form of interest to those who 

A second part of the consumption demand arises from those 
who wish to employ capital in the way of business to effect precisely 
the same kind of economy. Wholesale merchants borrow from 
the banks in order to distribute wheat and other agricultural 


produce through' the year in a manner which increases the utility 
it yields ; retailers need capital to carry the stocks of finished goods 
with which to meet the needs of the public as they arise. Waiting 
employed in this way is not cancelled by Anticipation ; it increases 
the capital stock of the community and earns interest by enabhng 
goods to be carried to those points of time at which the demand is 

We may then conclude that Waiting in response to the Con- 
sumption demand is a service which consists simply in enabUng 
things to be carried to the points of most urgent demand ; the 
product of this service being the additional utility which these 
things acquire from the transfer ; and this increase of utility 
forming the first of the two sources from which interest is paid. 

The Production Demand 

The Production demand for Waiting springs from a source 
quite distinct from that described above ; it arises from purely 
technical conditions in connexion with processes of production, 
and has become of increasing importance since the advent of the 
Industrial Revolution. 

In parts of the world where the bounty of nature is very rich, 
groups of people whose wants are simple may be able to satisfy 
their immediate needs without putting forth anything in the nature 
of Working or Waiting ; in such conditions the question of a 
cost or supply price of the things which satisfy these immediate 
needs does not arise ; for they are obtainable practically without 
exertion and there is enough for all. 

When, however, the bounty of nature is inadequate, and hunger 
and cold can be alleviated only by hunting and fishing, work 
becomes a necessary preliminary to the use of furs and meats ; 
food and clothing can be acquired only at a cost. In such circum- 
stances these simple economic goods will acquire an exchange 
value, for their supply will involve costs of production, and these 
costs may be said to consist simply of labour, of Working. 

But with the advance of knowledge and the increasing com- 
plexity of wants which accompany development towards the condi- 
tions of modern communities, production operations change their 
character ; Working ceases to be the sole element of cost, and 
Waiting, an element formerly imperceptible, becomes of increasing 
importance among costs of production. 

The cause of the introduction of this new element is of course 
simply economy and the cause of this economy is simply that the 
addition of Waiting to Working permits the adoption in many 
productive operations of alternative methods of higher productivity. 


An illustration of this change of method with its accompanying 
increase in productivity may be taken from the case of the fisherman. 

We may suppose the fisherman in primitive conditions to be 
working practically without appliances and to be consuming the 
products of his Working forthwith ; and, if we compress a period 
of slow evolution of knowledge into a point of time, we may suppose 
further that he is at the same time aware of an alternative and more 
effective method of obtaining these products by means of boat 
and nets. Suppose him then one morning to resolve to change 
from one method to another. Accordingly he decides to continue 
temporarily in his present ways, but to save, say, one-half of his 
produce for fifty days and to pay this to some other party to manu- 
facture for him the boat and nets he requires. At the end of this 
period he adopts the second method of production, and his daily 
produce, we may very reasonably suppose, shows a net increase 
of 20 per cent. 

The question to be answered is — ^to what is this additional 
produce due ? It is not due to increased Working on his part 
under the second method ; for, although the character of his efforts 
may have been changed, it may quite fairly be assumed that they 
are on the whole no more arduous or difficult than before. It is 
not due to increased working during the fifty days, for his work 
during this period underwent no change and his product was the 
same as before. It is not due to the increased Working of the 
other party ; for that other party has obtained fish indirectly by 
making boat and nets, instead, perhaps, of producing fish directly 
on his own behalf. Only one thing has changed ; one further 
thing has been done. The fisherman has abstained from consuming 
the products of fifty half days' labour ; these products constitute 
" free capital " ; they give him a " control of resources " which 
he devotes to the construction of the capital goods, boat and nets, 
thereby increasing the volume of his daily products. He may when 
he chooses re-exchange those tools for fish and enjoy the consump- 
tion he has postponed, but so long as he continues to postpone con- 
sumption, i.e. to Wait, his daily product is increased by 20 per cent. 

It is clear, therefore, that the difference between the productivity 
of the first and second methods of production is due simply to 
Waiting. This difference constitutes the Production demand for 
Waiting and is the second source from which interest is paid. 

The scope for the employment of Waiting in production uses 
evidently depends on technical considerations ; it depends on the 
methods of production which have been discovered and on the extent 
to which the adoption of the most efficient of these methods is 
facilitated by the use of a " quantity of value for a period of time." 
Its contribution to productive capacity varies then with the technical 


conditions of each trade and industry, ranging from a position of 
insignificance in the industrial operation of a washerwoman, through 
one of considerable importance in, let us say, cotton-spinning, to 
one of predominance in the case of ocean transport. In some 
operations roundabout methods offer little advantage ; in others 
they yield enormous economies. 

When capital is employed to allow a stock of wine to mature, a 
crop to ripen, or a forest to grow, its function is simply that of 
enabling a period of time to be interposed between human effort 
and its reward, during which period the forces of nature operate 
to produce a result unattainable by more immediate methods. 
The more typical use of capital is, however, to enable business men 
to adopt lengthy and roundabout modes of production when these 
are more efficient than more direct and immediate methods of 
attaining a similar end. It would be possible, for example, for 
business men to carry out their transactions by paying away their 
own products in the purchase of the various goods they require ; 
but in fact they do not do so, because they can carry through their 
transactions far more efficiently by adopting a roundabout method : 
namely, by exchanging their product for money, holding a part of 
their capital as a money stock and employing this stock to effect 
their payments, the economy so effected more than outweighing 
the loss of interest on the capital so employed. A clearer example 
is given in the comparison between two methods of transport, the 
one by coolie involving only Working, the other by means of a 
railway, involving both Working and Waiting. By the second, 
roundabout method, the operation of transport is carried out in 
two stages : in the first stage Waiting provides the food, clothing, 
etc., which enables Working to be applied to the production of a 
slowly made intermediate product, the railway ; in the second 
stage the railway, whose cost is borne solely by Waiting, is joined 
with more Working to produce transport services vastly more 
economical and efficient than those of a similar quantity of unaided 
labour. The increased efficiency of labour, due to the assistance 
of Waiting, yields a surplus over the results of the direct method 
which constitutes the source from which interest is paid. 

We may conclude then that the act of Waiting is an act of 
postponing consumption which releases for social use a quantity of 
value for a period of time ; its product is a supply of capital, the 
control over a quantity of social resources, which may be employed 
by the party who waits, or transferred to some other party through 
the agency of the Money Market. The use of this capital introduces 
two distinct economies ; it increases the efficiency of consumption 
(if the expression may be permitted) by enabhng things to be carried 
to those points of time at which they satisfy the most urgent 


(money) demand ; it increcises the efficiency of production by making 
possible the adoption of methods of higher productivity ; in each 
use it yields a net gain of utility which is the source from which 
interest is paid. 

The annual supply of free capital, the stream of resources 
seeking investment, is partly applied by its owners to maintain 
and extend their own business operations, partly transferred to 
other parties through the agency of the market. In either case 
the Waiting from which this capital arises is inseparably bound up 
with other (real) costs. 

When the investor employs his capital in his own business his 
Waiting is associated with the exercise of the business ability 
required for the management of his undertaking. When he trans- 
fers his capital to the control of other parties, " work of manage- 
ment " is still necessary both for dealing with the risks to which the 
capital is exposed and selecting the employment in which it may 
be expected to yield the highest net return. It is mainly by 
separating Waiting from this work of management that the market 
exerts so powerful an influence in increasing the volume of Waiting 
annually supplied. It does so in two ways. 

The market agencies themselves may assume, in part or in 
whole, the work of risk-bearing and marketing, and by their expert 
knowledge and wide business connexions greatly increase the 
efficiency with which it is done. Deposit and Savings banks take 
over the whole of this work from the investor, relieving him of all 
but the service of Waiting. Trust and Investment companies 
(cf. pp. 118-21) relieve the investor of part of his risks and most of 
the work of marketing ; they open for him an immense and o' her- 
wise inaccessible field for the profitable employment of his capital. 
The Jobber's " turn " and the Broker's commission are payments 
for work of management which few investors would care to under- 
take themselves. 

A second method, similar in principle, is that adopted by Issue 
Houses, company promoters and so on in the sale of securities to 
the public. The stocks and shares which they market are differ- 
entiated in adaptation to the needs of different types of investors : 
some such as mortgage debentures are so devised as to be almost 
free from risk ; others such as preference shares bear limited 
risks ; others such as ordinary shares have concentrated on them 
most of the risks of the undertaking they represent. 

It is easy to see that these two methods are no more than 
special applications of a very general principle. Just as the 
complex operation of producing goods is separated into its simpler 
processes and these processes assigned to specialized classes of 
workpeople, business men and capitalists, so the complex service 


involved in the supply of capital is separated into its elements and 
each elementary service assigned to the party who will supply it 
most cheaply. The effect of the application of these methods, on 
the supply of capital and the development of industry, can hardly 
be estimated ; but it seems clear that if each investor were required 
to deal himself with the risks and trouble of marketing his capital, 
the annual supply of Waiting would be only a small fraction of its 
present amount. In the following chapters the economies effected 
by the market in that part of this work which they take over from 
the investor are examined in more detail. 





FOR the sake of simplicity Waiting has been dealt with as 
though it were a distinct and independent service ; in fact, 
however, as Waiting essentially implies the carrying of 
some thing of value from the present to the future, its 
supply, as already noticed, is necessarily associated with that of 
another and quite different service. As the value of the thing 
carried depends upon the events of a future never perfectly fore- 
seen, that value is subject to change uncertain both in kind and 
degree. Accordingly anyone who Waits, or carries any thing of 
value through time, must accept the risk of change to which its 
value is exposed ; in other words, the service of Waiting is essenti- 
ally bound up with that of bearing Risk. 

Given a complete knowledge of the future, it would evidently 
be possible to make a much more exact and delicate adaptation 
of economic means to economic ends than is practicable in the 
circumstances in which business is actually carried on. In such a 
condition volcanic eruptions would destroy only that property 
which awaited demolition ; hailstones would fall on crops and 
leave their value unaffected ; changes in wants would coincide 
with the decay of the industrial plant which served to satisfy them ; 
the terms gain and loss would be deprived of that greater part of 
their significance which is derived from the presence of chance. 

In actual fact, however, not only can the changing environment 
of the future be foreseen only very imperfectly, but the present 
environment itself is inadequately known. Consequently the 
adjustment of means to ends is at best only a succession of approxi- 
mations. Incessant change in the extent and kind of wants is 
followed by incessant readaptation of industrial machinery ; and 
the cost of imperfect knowledge is a continuous maladjustment, 
which lowers the efficiency and therefore the productivity of 
resources, and gives rise to a continuous social loss. 

The amount of this loss depends on three things : (i) the 
rate of social change ; (2) the degree of imperefction of knowledge ; 


and (3) the extent to which resources are fixed and unadaptable, 
i.e. the immobility of invested resources. 

The rate of social change is evidently important. A Republican 
victory in the United States of America is thought perhaps to 
foreshadow trust and tariff legislation. A typical effect would 
be that prices of certain stocks tend to fall ; in other words, 
people will not buy those stocks, and new capital will not flow into 
the industries which those stocks represent, until the rate of return 
rises by an amount which will cover the cost of bearing the addi- 
tional risks which have been introduced. Again, capital invested 
in plant for the production of fashionable goods must normally 
yield a higher rate of interest than capital applied to produce goods 
of more stable consumption ; the additional charge for interest 
increases the cost of the goods sold to the consumer and is, as it 
were, the price, or at any rate a part of the price, of the more rapid 
social change. Instances could evidently be multiplied, were 
it necessary, to show how great is the waste introduced by the 
presence of unforeseen change. 

The future may be controlled to some extent by the develop- 
ment of stable political institutions, by laws for the enforcement 
of contracts, and by the growth of morality which increases the 
stabihty of business relations ; uncertain future events may be 
set off against one another by the operations of Insurance com- 
panies, and liability may be limited by special legal devices. Never- 
theless, there remains a ceaseless and increasing change which may 
often consist in the introduction of new inventions and of improved 
processes, but, in itself, adds greatly to the risks of invested 
resources and constitutes a very important element in costs of 

The second determinant of the amount of risk which is borne 
by a society is the extent of ignorance, without which change 
(from this point of view) is harmless. The social machinery for 
dealing with this ignorance by collecting and distributing intelli- 
gence is extensive and elaborate. The Meteorological Office increases 
the efficiency of resources employed in navigation and agriculture ; 
the speculative produce markets pubhsh anticipations of the 
future in terms of price quotations, and by so doing co-ordinate 
supply and demand more closely ; while many thousands of people 
speciaHze in the collection of information bearing on the present 
conditions and future prospects of business undertakings through- 
out the world. The commercial and financial articles and market 
reports annually published in the periodicals of the U.S.A. alone 
would, it has been estimated, make nearly two hundred and seventy- 
one millions of books of the size of David Harumr* All this 
intelligence, distributed by the technical and general press, must 


diminish very greatly the risks of investment or, more generally, 
the wastes arising from the maladjustment of social resources. 

Given, then, the rate of change in a society, and also the state 
of knowledge, the amount of risk depends upon a third factor — 
the degree of mobility of invested resources. Evidently the losses 
inflicted by unforeseen change, whether they proceed from the 
introduction of new methods of production, from changes in taste 
or from political upheavals, will depend very closely upon the 
power to recover or to readapt the form of the fixed capital which 
was adjusted to the necessities of the original economic conditions. 
Every increase, therefore, in the amount of fixed capital used in 
a production process or in the degree to which it is specialized 
diminishes, ceteris paribus, this power of readjustment to changing 
circumstances and increases the amount of risk associated with 
the production process in question. When resources are invested 
in the construction of a highly specialized plant, or when a workman 
spends many years in acquiring skill and speed in performing some 
delicate specialized process, the risk of loss on the capital invested 
is evidently far greater than when plant and personal abilities, 
being less highly differentiated, can be diverted to other uses 
as circumstances require. 

Although, therefore, it may be hardly possible to prove the fact 
inductively it is impossible to resist the inference that the more 
permanent and highly speciahzed are the forms in which resources 
are embodied, the higher, other things being equal, must be the 
rate of return on these resources, in order that adequate compensa- 
tion may be received for the additional risks which permanence 
and specialization introduce. 

These three determinants of the amount of risk borne by a 
society are interdependent, but they represent distinct sources. 
It will be convenient to deal with the first two together under the 
heading " Risk arising from Imperfect Knowledge," and then, 
assuming the imperfection of knowledge to be given, to pass on 
to a consideration of the additional risks introduced by the immobilty 
of resources. We recognize, therefore, two main sources of risk and 
deal with them in successive chapters. 




I. Risk arising from Imperfect Knowledge 

A STOCK EXCHANGE list for April 1914 gives the yield 
at current prices of the two kinds of stock issued by the 
United States of America Steel Corporation ; the Pre- 
ference Stock yields £6, 6s. per cent, the Ordinary £7, 15s. 
per cent. As each of these stocks has a large and active market, 
so that the ease of buying and selling is practically the same in the 
two cases, the difference in yield of £1, gs. per cent must be regarded 
as a payment for the additional risk borne by the holders of the 
Ordinary Stock. This difference of yield of which we are speaking 
is not, of course, based on the rates of return on the original capital, 
but on the rates of return which would be obtained on capital 
invested in the two kinds of security at current prices. The presence 
of this difference is quite in conformity with the accepted opinion 
that risky securities must pay a higher rate of return than others ; 
but the nature of the service for which this additional payment is 
made is less evident than at first sight it appears. 

It seems often to be considered that this additional yield is a 
kind of bonus which appears in good years as a compensation for 
low dividends in the past or an anticipated decrease of yield in 
leaner years to come, that is to say, that the additional yield is 
a kind of amortization fund which just serves to cover losses in 
the past or future. This view must be true in part ; for capital 
invested, for example, in shipping, where it is exposed to a possi- 
bility of loss, must j^eld a return which would be sufficient in the 
long run to make good this loss. If, however, the additional yield 
merely compensated for losses, it is evident that in the long run 
the return on risky securities would be exactly the same as the 
return on those which were perfectly safe, a view which is not 
borne out by the facts and is in conflict with accepted opinion. 

Suppose for the moment that this theory were true, and that 
the public would hold risky stocks for the same average return as 
it could obtain upon others. Now in the case of such stocks as 
those of sound, old-established railways the long records of the 
dividends paid give in normal times a good experience on which 


to base an estimate of their future behaviour. Sound Preferred 
Stocks, bearing a fixed rate of interest, may be expected to continue 
that yield during any period the investor is likely to take into his 
calculations. The corresponding Ordinary Stocks, the yield on 
which fluctuates more closely with the fortunes of the railway, 
may be expected to pay the same average return as before, for there 
would seem to be no greater chance of the yield sinking to nothing 
than of its rising to double the average rate. On the present 
assumption, therefore, it would be expected that the opinion of 
the market, corrected by its past experience of these securities, 
would set the price of the Ordinary Stocks at a level which would 
make their average yield equal to the average of the fixed rates 
paid on the Preferred Stocks ; that is to say, that the anticipated 
yield on £ioo invested at these prices in Preferred or Ordinary 
Stocks would be the same in amount and would differ only in the 
fact that in the case of the former the yield was comparatively 
fixed and certain and in the case of the latter the yield might 
fluctuate widely about the average. 

In fact, however, this is not the case. Current prices of Ordinary 
Stocks, not only of railways but of other old-established companies, 
are set at a level which makes their current yield higher than that 
on the Preferred Stocks. It would appear, therefore, that a higher 
average return is expected from the Ordinary Stocks and that in 
fact capital invested in certain classes, the risky classes, of security 
is expected to obtain a permanently higher rate of return than capital 
invested in other classes of security where the return is quite 
certain, a fact which is quite unexplained by " Risk *' in the sense 
in which it seems frequently to be employed. 

There must therefore be present some deterrent, some dis- 
utiHty, attaching to the supply of capital in these particular classes 
of risky security, which checks the flow of capital into them and 
thereby raises their rate of return by an amount which constitutes 
the market price for bearing this disutility, i.e. this additional 
element in the supply price of capital. This deterrent to the supply 
of capital can arise only from the fact that people do in general 
dislike the uncertainty in the yield of risky investments even 
though experience may show that in the long run these investments 
will yield them a return equal to that derived from other classes of 
investment. The disutility in question therefore arises from the 
presence of Uncertainty, and the service for which this additional 
return is paid is the service of bearing Uncertainty. 

The supply of capital in risky investments would appear there- 
fore to involve the bearing of Risk, in the sense of an unrelieved 
probability of loss, and the bearing of Uncertainty, in the sense of 
irregularity of return ; the presence of the one being very gener- 


ally taken for granted, the presence of the other being suggested, 
though hardly proved, by the foregoing discussion. Both these 
ideas may be run together in a conception developed by Professor 
Pigou in his Wealth and Welfare, a conception which so completely 
satisfies the mind that it requires explanation rather than proof. 
The essence of the matter lies in the idea that the presence of risk 
in any venture checks the flow of capital into that venture until 
the rate of return rises and there appear chances of exceptional 
gain which compensate for the chances of loss and the uncertainty 
of the return. A risky investment differs from a safe investment 
therefore in offering not a single fixed and certain net return but a 
range of prospective net returns. This must be considered more 

Suppose a capitalist to be making his choice between invest- 
ment in two securities, the one practically safe, the other risky. 
Suppose him also to neglect future capital value and look only at 
future yield — this he may quite properly do, for the two are bound 
together by the rate of interest and move symmetrically. When 
he contemplates the safe security and looks at its future yield he 
estimates perhaps that he is practically certain to get a net 4 per 
cent, but that there are a few chances of his getting 3 per cent, 
and about an equal number of chances of his getting 5 per cent. 
When, however, he regards the probable j^eld from the second 
and more risky security he estimates perhaps that while there 
are most chances that he will get 5 per cent, yet there are a vary- 
ing number of chances of his getting anything from -5 to + 20 
per cent. 

These two sets of conditions may be represented by curves of 
" prospective net returns." These curves are drawn separately 
for the two securities. In each case the prospective rates of return 
on the sum invested are measured along OX and the number of 
chances of each rate of return is measured along OY ; thus the most 
frequent return MP is Hkely to occur OM times. In each case the 
*' spread " of the curve represents the amount of Uncertainty in each 
investment or venture for which it is drawn. The average return 
which may be anticipated, i.e. the estimated actuarial value of 
the set of prospective returns, may be shown by drawing M'P' ; 
then if we mark off the length MT" equal to the net rate of interest 
(in the generally accepted meaning of the phrase) the difference 
between the two, i.e. P'— P', represents the payment for bearing 

This conception is complicated by the difficulty of defining the 
degree of knowledge to be presumed in forming the estimates of 
the prospective net returns proper to any venture ; for its prospects 
will present themselves in a different form to each individual 



investor. For present purposes it will be convenient to conceive 
the curve to be drawn in the light of the knowledge possessed by 
well-informed parties in the market. That being so, we may 
regard the actuarial value of its set of returns as a measure of its 
true social title to be suppUed with the capital of which it is in 

When these prospective returns are very widely spread ; when, 


















O Rates of return 








/ ^^ 




for instance, as in lotteries and untried gold mines there are a few 
chances of immense gains and many chances of none, it may be 
that the attractive power of the curve will be so great that capital 
will flow into the venture when the actuarial return M'P' is below 
the net rate of interest. In such cases there is no payment for 
bearing Uncertainty, or rather the payment is negative, for MT' 


is less than M'P". It must be admitted, however, that in general 
people dislike uncertainty in the return on their investments, and 
accordingly that if capital is to flow into any undertaking the 
estimated actuarial value of its curve, M'P', must usually exceed 
the net rate of interest by an amount which constitutes a payment 
for the Uncertainty borne. 

Normally, therefore, it is to be expected that, as the spread of 
the curve narrows, its actuarial value M'P' declines and approxi- 
mates more and more closely to the net rate of interest until, 
when the venture offers regular and certain returns. Uncertainty is 
eliminated and M'P' coincides with the net rate of interest MP. 

It will be noticed that the idea of Risk as an unrelieved prob- 
ability of loss is now included as a part of this more general con- 
ception, Uncertainty. The term Uncertainty is, however, both 
clumsy and unfamiliar, and it will be convenient to abandon its 
use in favour of the term Risk on the understanding that this term 
will in future be used here with the wider and not the narrower 

Risk, viewed in this way, is a perfectly general conception ; 
it is associated not only with the supply of capital but with the 
supply of effort of all kinds. It is borne by the labourer who 
works for a fluctuating wage, by the retailer who carries a stock 
of merchandise and indeed by every person whose operations require 
him to carry things of value through time and thus to expose them 
to influences which he cannot adequately foresee. 

As already noticed, it must not be assumed that the bearing 
of this Risk is invariably an onerous service which commands a 
price, for the evil which it contains may in many cases be obscured 
by natural optimism or outweighed by the love of excitement. 
" The overweening conceit which the greater part of men have of 
their own abilities," says Adam Smith, " is an ancient evil remarked 
by the philosophers and moralists of all ages. Their absurd pre- 
sumption in their own good fortune has been less taken notice of. 
It is however, if possible, still more universal. . . . The chance of 
gain is by every man more or less overvalued, and the chance of 
loss is by most men undervalued, and by scarce any man who is in 
tolerable health and spirits, valued more than it is worth." ^s Per- 
haps the most striking example of unpaid Risk-bearing is that of 
participation in lotteries. The actuarial value of the chances of 
gain must always be less than the price of the ticket, but the 
possibilities of large gain affect the mind more powerfully than the 
chances of small losses, and as a consequence the resources, even of 
those who understand the chances, flow steadily into a venture 
which consistently pays a dividend of less than nothing. For 
similar reasons the amateur speculator does a great deal of Risk- 


bearing — particularly in connexion with new issues — for which 
there is every reason to believe he usually receives on the average 
no payment at all. 

This kind of Risk-bearing is, however, associated with the world 
at play rather than with the world at work. Under the rationalizing 
influence of business. Risk soon becomes recognized as an evil and 
Risk-bearing accordingly as a service which is to be undertaken 
only at a price. Both a priori considerations and the evidence 
summarized in market rates of interest go to show that in general 
Uncertainty or Risk is a deterrent to the supply of capital, and 
that the greater the amount of Risk associated with an enterprise, 
the greater must be the payment, over and above the net rate of 
interest, to attract Waiting and Working into that enterprise. 

Pure Waiting is the service of supplying capital for a net return 
which is fixed and certain. Risk-bearing is the service which is 
added when for this fixed and certain payment is substituted a set 
of prospective net returns. We may, therefore, conclude provision- 
ally that the supply price of capital to any enterprise consists of 
the net rate of interest plus a market price for Risk-bearing deter- 
mined by the kind and amount of Risk present. This additional 
payment is shown diagrammatically by the length P* — P'. 




2. Risk arising from Immobility of Invested Resources 

IN discussing the nature of Risk in the preceding chapter 
the point of view adopted was that of resources passing 
into a variety of employments in each of which they were 
exposed to a special set of risks ; that is to say, the Risk 
considered was that which had its source mainly in the amount of 
unforeseen change. 

The Risk arising from this source is fairly well understood and 
needs no further consideration at the moment. We may, therefore, 
assume " the amount of unforeseen change " to be given and pass 
on to examine more fully the Risk arising from the second source 
which has been distinguished, i.e. the imperfect abiUty to readjust 
business arrangements to changing conditions. 

It has already been argued that, when a business man in the 
face of a changing environment proceeds to adjust economic 
resources to meet economic ends, the amount of Risk which he 
bears increases with every increase in the degree to which these 
resources are fixed and speciaHzed, or more exactly, in the extent 
to which he has lost his power of rapidly readapting these invested 
resources to meet changing conditions. It may be that he recog- 
nizes a keen coming demand for goods which his machinery is 
not well adapted to produce, or that he experiences a sudden and 
permanent fall in the demand for his own products ; his ability 
to meet either opportunities or emergencies is weaker the greater 
the immobility of his resources. 

As this enforced immobility of resources increases the risks which 
he bears, and as Risk-bearing is a service which must in general 
be paid for, it inevitably follows that he will not commit his capital 
to fixed forms without the prospect of proportionately increased 
net retimis ; that is to say, ceteris paribus, the rate of return on 
his capital must increase with the degree to which its employment 
requires it to be embodied in forms which are fixed and irrecoverable. 
We have now to extend this conception of immobility to include 
not only the capital which the business man locks up in his own 
undertaking, but also that capital which he (or any other person) 



renders in some measure unavailable by supplying it to other parties 
for considerable periods of time. 

In some businesses, such as that of an ironmaster, the greater 
part of the invested capital is in the form of fixed plant ; in others, 
such as that of the merchant or banker, the greater part may be 
invested in goods or securities ; in all cases, however, the risks of 
changing circumstances are increased with every increase in the 
immobility of these resources. If it is true that capital invested in 
iron-producing plant earns an additional return because of its 
inability to transform itself in response to changes in demand, it 
is also true that capital invested by the merchant in goods which 
are not immediately marketable earns an additional return because 
it cannot be readily withdrawn to meet emergencies or oppor- 
tunities arising in connexion with other lines of goods. In a 
precisely similar way the capital lent to other persons by iron- 
master, merchant or banker must earn a higher rate of return in 
those investments from which it can be withdrawn only with time 
and difficulty than in those from which it can be recovered on 
demand. This additional return is a compensation which the 
investor will require for his impaired ability to meet unforeseen 
changes in his circumstances, i.e. it is the price of bearing the 
additional insecurity which has been imported into his business 
situation. We have now to inquire whether the bearing of this 
additional risk, which it is convenient for the time being to describe 
as Insecurity, is in fact a service which commands a definite price 
in the Money Market. 

Let A be a person representative of the supply side of the Money 
Market and let B be a person representative of its demand side. 
If A contracts to supply capital directly to B the terms of the 
contract will contain secondary provisions, the most important of 
which are concerned with the period of the supply and conditions 
of repayment. The advantages of these provisions may be assigned 
to one party or the other. In the one extreme case where the 
period of supply depends on the will of A, these advantages 
fall wholly to him ; this happens, for example, when he lodges 
money on deposit with a bank on the understanding that he may 
withdraw it when he chooses. In the other extreme case, where the 
time of repayment rests with B, these advantages fall entirely to 
him ; such a case would arise if B, as a joint -stock company, were to 
issue debentures which were repayable at his own convenience. 

In the first case A can recover his capital on demand ; it is as 
readily available as if he held it in cash ; the supply of this capital 
introduces no additional insecurity into his business position, and 
we may reasonably suppose that it is free from any other kind of 
risk. The rate paid under this type of contract will, therefore. 


be the price of pure Waiting, the net rate of interest. We may, 
therefore, take this type of contract as a basis and measure from 
it the price of bearing the insecurity which falls upon A with any 
variation in its terms. This is most conveniently expressed by a 

Let A's total supply of capital ON be represented by a curve 
showing the various maximum lengths of time at which for a given 
rate of interest he will be willing to offer the different parts of his 
available resources, and let B's curve be a similar analysis of his 
total demand for ON capital, showing the minimum periods for 
which he demands the various quantities at that rate of interest. 

Period of 
time for j 
which each i 
quantity is i 
supplied or i 


BS CURVE OF demand! 




Finally, let it be supposed that there are no other elements in the 
supply price of capital except the net rate of interest and the 
price which compensates for the imperfect availability of capital 

It seems evident that A will be unwilling to supply more than 
a small proportion of his available resources for any considerable 
length of time, for otherwise he will greatly weaken his power to 
meet his business emergencies. It seems evident too that the 
greater part of B's demand will be for the use of capital for long 
periods ; for he will require it mainly for the durable apparatus 
of production, railways, buildings, machinery, and so on. Further, 
A's curve of supply is not likely to show much elasticity, that is. 


much change of form in response to variations in the rate of interest 
offered ; for his insecurity will increase fast as the period of supply 
lengthens, and this will prevent him from lending more than a 
small part of his free resources for any considerable period of time. 
If the rate of interest is now allowed to vary with the period of 
supply, A's curve may assume the second position, showing that, 
even for higher rates, he will lend only a part of his capital for 
only moderately increased periods of time. This interest will be 
simply a payment for the additional Insecurity falUng on him. 

It appears, then, that in the direct supply of capital from A to 
B there would be a series of bargains, i.e. of equilibria between 
demand and supply, corresponding to the different periods of 
supply ; only a comparatively small amount would be marketed 
at rates of interest which would rise sharply as the period 
lengthened ; the burden of Insecurity would cause the greater part 
of loanable capital to be supplied only for short periods, and the 
extensive use of capital in durable production processes would be 

In fact, however, the greater part of capital is supplied, not 
directly, but through the intermediate organizations of the Money 
Market, whose operations effect a very great reduction in the 
Insecurity associated with the supply of capital for long periods. 
The method by which these organizations reduce this Insecurity 
lies in the adoption of the principle which underlies insurance. In 
the typical case. Insecurity springs from some temporary emergency 
for which immediately available resources are required ; it arises 
in a large measure not from general causes but from the particular 
business circumstance of the individual capitalist. If therefore 
the effects of these independent events can be pooled, the temporary 
shortage of one capitalist can be set off by the temporary plenty 
of another, the one cancelling the other. In practice the method 
adopted consists in the provision of a market by which a large 
number of the parties supplying capital are brought into touch 
with one another. By this means any capitalist who wishes to 
recover invested resources is enabled to do so, not by withdrawing 
it from the party who is applying it to its productive uses, but by 
shifting the work of supply on to some other capitalist willing to 

The banks, in effect, make such a market for their depositors 
by pooling a large number of individual accounts, an arrangement 
which enables any depositor to lodge or withdraw resources in 
accordance with his particular circumstances without imposing 
on the bank the necessity of recalling these resources from the 
parties to whom it has lent them. In this way the banks eliminate 
practically the whole of the Insecurity, which, in conditions of 


direct supply, would arise from loans yielding a rate of interest such 
as they pay to those who deposit with them capital repayable on 

The economy effected by the Stock Exchange depends on pre- 
cisely the same principle. In most cases the securities dealt with 
on this market are representative of capital supplied for very long, 
even indefinite, periods. Probably only a small fraction of that 
capital would have been forthcoming were it not that the element 
of Insecurity in the costs of supply has been reduced by the ease 
with which the capital may be recovered, not indeed from the party 
to whom it was originally supplied, but from some other party 
desirous of investment. 

Again, in England, Germany and France the rate at which 
sound bills are discounted is regularly lower by J to i per cent 
than the rate at which loans are made for similar periods against 
equally good security. This difference is evidently due to the 
marketability of bills ; that is, to the greater availability of resources 
invested in them ; it gives a precise measure of the difference in 

These facilities for the recovery of resources apply to so large a 
part of the total supply of capital that in the gaps where no organiza- 
tion exists for the purpose — such as solicitors' mortgages — ^long 
loans can be made with that capital which people prefer to supply 
for considerable periods of time, so that over the whole range of 
periods only comparatively small differences of rate accompany 
the different degrees in which invested resources are available. 

These differences of rate, although greatly reduced by the market, 
are still quite appreciable. When capital is supplied for an indefinite 
period to a joint -stock company whose shares have only a narrow 
market, the price of these shares will be depressed, that is to say, 
their return at current prices will be high, in order to yield a pay- 
ment which compensates shareholders for their imperfect ability 
to recover their resources. When capital is invested in Consols 
which normally have a large and active market this payment is 
less, but it must still be sufficient to compensate the stock-holder 
for the charges of jobber and broker which must be incurred if he 
wishes to recover his capital. When capital is lent on deposit to 
a bank, this payment falls almost to zero, for the loans can be 
recovered without cost practically on demand, and the return is 
substantially equal to the net rate of interest. If, finally, the 
capital is transferred from deposit to current account, the income 
of net interest is exchanged for a positive return of convenience 
and security derived from the services of money, its marginal yield 
being equal to the interest foregone. 

The same considerations which affect the individual capitalist 


affect also the intermediary dealers in capital. The banks supply 
the capital at their disposal in a series of loans and investments 
ranging from those outstanding for several years to those recover- 
able on demand. The net rate which they charge tends to the 
same level throughout, but the gross rate varies, among other 
things, with the period of supply. Given that the security is 
equally good throughout, the highest rates are obtained on their 
long loans ; lower rates, as we have already seen, are charged on 
bills ; lower rates still on capital supplied *' at call " ; finally their 
lodgments with the Bank of England yield them an equivalent 
of the net rate in convenience and security. 

Bankers' loans *'at call" involve practically no risk of default 
on the part of the borrower and none of that special kind of risk 
which we are for the moment describing as Insecurity. The average 
return on these loans should then be equal to the net rate of interest, 
that is to say, to the average rate paid to the public for their de- 
posits, except for a small payment which compensates them for 
work done in marketing the capital. This point may be examined 
statistically. The average ** call " and " deposit " rates for a large 
group of London banks during the period 1900-6 were 2*6 per 
cent and 2*0 per cent respectively, showing a difference of '6 per 
cent going to the banks as a payment for the work described. 
During the same period the average deposit rate of the London 
Discount houses was 2*4 per cent and their average discount rate 
for 60-day bills was 3*02, showing a difference of -6 per cent for 
work similar to that done by the banks. So close an agreement 
between these figures is no doubt largely accidental, for there are 
several minor considerations of which no account has been taken. 
But the result of the comparison is harmonious with the view that 
there is a market price for each of the services involved in the 
supply of capital ; it therefore supports the argument that Insecurity 
is a cost susceptible of a money measure and that its price may be 
deducted from actual rates of interest to leave a net rate of interest 
in the sense defined. 

The conclusion of the present chapter is, then, that the invest- 
ment of resources in forms from which they cannot readily be with- 
drawn, whether the forms are those of fixed plant or of claims 
against other persons, weakens the ability of the party supplying 
those resources to deal with the opportunities and emergencies 
arising from unforeseen changes in his circumstances. It gives 
rise, therefore, to that particular kind of risk which we have dis- 
tinguished as Insecurity. As an element in the costs of production 
of capital Insecurity is of great importance and would be a strong 
deterrent to the supply of capital for long periods were it not for 
the effective work done by the market in reducing its amount. 


But, although this cost is greatly reduced, the price corresponding 
to the residuum still forms an important element in the supply 
price of capital — a price which varies with the difficulty of recover- 
ing the capital supplied, and amounts even in the case of fairly 
short loans (as compared with bills) to as much as J to i per cent per 
annum. So far, then, we have the supply price of capital as com- 
posed of two elements — the market rates for Waiting and for bearing 
Risk. The price of pure Waiting, i.e. the net rate of interest, is 
the price paid for the service of supplying capital for a period 
terminable at will in exchange for a fixed and certain return. It 
corresponds very nearly with the average rate paid by a bank of 
high reputation in exchange for lodgments on deposit account 
repayable on demand or short notice, and would be practically 
identical with the yield on gilt-edged stocks if there were no charges 
to be paid to broker and jobber on the purchase and sale of the 
securities. The price of Risk-bearing consists of two elements : 
first, the additional rate which must generally be paid when for 
this fixed and certain return is substituted a set of prospective 
net returns ; second, the further additional rate which must be 
paid when the party supplying the capital cannot recover it at wil 1 
to meet the emergencies and opportunities arising from his particular 
business circumstances. 





THERE is in the supply price of capital a third element 
in addition to those which have already been considered. 
Just as the supply price of coal contains, over and above 
the price of getting it out of the ground, a payment for 
conveying it into the hands of the consumer, so the supply price 
of capital must include a payment over and above the price of 
Waiting and Risk-bearing for work done, either by the capitalist 
himself or by the market on his behalf, in placing that capital at 
the disposal of those who employ it in its business uses. 

It is not very easy to say just what work should be included in 
the definition of this residual service; as a first approximation 
the work may be defined as that done in finding the party to whom 
the capital is to be supplied, carrying that capital to him and 
recovering it from him at the end of the period of supply. 

It would not be worth while discussing the accuracy of this 
definition were it not that under cover of this discussion we may 
conveniently deal with one or two minor points which might, if 
unexplained, give rise to ambiguity. In the first place, we may 
attempt to justify the definition. 

When a quantity of coal has once been supplied to the t^onsumer 
the costs of the operation are complete and the transaction is closed. 
When, however, capital is suppUed, the costs of Waiting and Risk- 
bearing run on continuously throughout the period of supply, and 
this period is bounded at each end by a marketing operation in- 
volving work which, it would seem, must necessarily be included 
as a part of the total costs of supply. It would then be in accord- 
ance with common sense to regard the transaction as completed 
only when the capital is back again in the hands of the capitalist. 

But a difi&culty in this view arises from the fact that capital 

may be supplied in two ways. It may be supplied by way of loan, 

as when a banker lends to his customer or when the public subscribe 

to an issue of debentures ; or it may be supplied by way of purchase, 

as when the public finances a new company by buying its ordinary 

or preference shares. The legal distinction between these two cases 



is an important one. In the former, the capitahst becomes a creditor 
entitled to recover from his debtor a fixed sum of money. In the 
latter, he becomes a part proprietor with no power to recover his 
capital from the company to whom he has supplied it ; from a 
legal point of view the transaction is complete when the shares 
have been bought, and no further marketing work remains to be 
done. The former case raises no difiiculty. The marketing work 
done by the banker is completed only when he has got back into 
his own hands the capital which he has lent. The latter case 
raises the difficulty that the marketing work is apparently complete 
when the capitalist has made over his capital to the company 
whose shares he has bought. 

A capitalist who has bought the shares of a company is certainly 
a part proprietor of the business, and as such incurs certain rights 
and responsibilities ; but, in fact, he has usually little more power 
than a debenture holder in controlling the manner in which the 
Directors employ the capital which he has supplied to them. More- 
over, although he will have been aware when he bought his shares 
that he could not recover his capital from the company, he would 
not usually have supplied that capital unless he knew also that, 
if he wished to do so, he could recover the value of his shares from 
some other capitalist by selling them on the market. As there- 
fore he has practically no control over the capital he has supplied 
and can usually recover the value of his shares at will, he is in 
effect lending his capital to the Board of Directors ; and we may 
reasonably regard his capital as having been supplied, like that of 
the banker, by way of loan. That being so, the work done by the 
Stock Exchange in enabling him to sell his shares at will may be 
regarded as that work of marketing which was missing in his case — 
the work of getting back into his own hands the amount of capital 
which he has supplied, increased or diminished by the special risks 
to which it has been exposed. 

From the economic, though not from the legal, point of view, 
therefore, the arrangement appears to be quite symmetrical. The 
supply of capital, whether by way of loan or by way of purchase, 
involves marketing work which may be defined as that of finding 
^ the party to whom the capital is to be supplied, carrying the capital 
to him and recovering it from him at the end of the period of supply. 
And this definition appears to be an accurate statement of the 
remaining service which, with Waiting and Risk-bearing, constitutes 
the total cost of supplying capital. 

Nevertheless this definition is not in harmony with the preceding 
analysis of the costs of supply ; it overlaps the definition of risk- 
bearing. Any complete account of the risks borne by the capitalist 
in supplying capital must include that special kind of risk which 


arises when he invests his capital in employments from which it 
cannot readily be withdrawn, or supplies it to other parties on 
terms which do not permit him to recover it at will in order to 
meet any unforeseen change in his business circumstances. But 
when this risk-bearing is reckoned as a part of the costs of supply 
it becomes necessary to reckon as a reduction of risk-bearing the 
work done by various parts of the market organization, in particular 
by the Stock Exchange, in enabling him to recover at will the 
capital he has supplied. This same work, however, has been included 
in the definition of marketing as the work of recovering the capital 
from the party to whom it has been supplied. The effect of this 
work in reducing the costs of supply has, therefore, been counted 
twice : once as a reduction of risk-bearing, and a second time as 
a reduction of the costs of marketing. 

The difficulty then is to decide under which head this par- 
ticular work is to be assigned. Ought we to class under Risk- 
bearing or under Marketing the work done by the various parts of 
the market organization in assisting the capitalist to recover his 
capital at will ? The answer seems to be that in neither case can 
a completely satisfactory analysis be obtained ; but that for con- 
venience of exposition the work should be assigned at one time to 
the one heading and at another time to the other. In the general 
analysis of the costs of supply which occupies most of the earUer 
part of this book, this work is dealt with under Risk-bearing in order 
to bring out the full efects of the work done by the market in 
reducing this element of cost. In the latter part of the book, 
however, where we are concerned with the method of operation 
of the individual Agencies forming the market, this same work is 
dealt with as a constructive marketing economy which consists in 
adding together short lengths of capital, thereby converting " short " 
into " long " capital and lowering the supply price of capital 
available for long periods of time. As the main consideration 
is that of determining the influence of the market in reducing the 
costs of supply the question whether any particular part of its 
operations should be reckoned as reducing the costs of Risk- 
bearing or of Marketing is comparatively unimportant, though 
it is as well to be aware of the method of accountancy actually 

This difficulty of definition is of little theoretical, and no practical, 
importance. Its statement serves, however, to bring out the fact 
that these two services. Risk-bearing and Marketing, are insepar- 
able even in theory and inextricably blended in practice. For 
example, when a banker is selecting the party to whom he shall 
lend — when he is marketing his capital — he is at the same time, 
and by the same effort, selecting the party to whom he can lend 


safely, that is to say, he is reducing his risks ; and no form of words 
can separate the one from the other. 

In these circumstances it is useless to attempt any separate 
examination of the practical operations involved in marketing. 
The only plan is to deal with the two kinds of work together under 
the general head of " work of management," examining the 
economies effected in its cost by the expert organizations of the 
market, and trusting that the discussion will throw up to the 
surface the distinctive characteristics of marketing work proper. 
A later chapter, therefore, contains a general review of the work 
done by the various Agencies forming the market, designed to 
show the characteristic economy effected by each type of 

Meanwhile we may define the supply price of capital as com- 
posed of three elements. The first is the net rate of interest, the 
price of pure Waiting, the rate paid for capital recoverable at will 
supplied in exchange for a fixed and certain return ; this rate is 
practically equivalent to the average yield obtained from invest- 
ment at current prices in first-class securities with a large and active 
market. The second is the price of Risk-bearing, the additional 
rate obtained when (a) for this fixed and certain return is sub- 
stituted a set of prospective returns and (b) the capital is not re- 
coverable at will ; this rate may be partially isolated by comparing 
the average yield of securities which differ in the range of their 
prospective returns or in the facility with which they may be sold. 
The third element is the price of those residual services involved in 
carrying capital between the two parties concerned, which are not 
included under a preceding head. 




THE social importance of the work done by the market 
cannot be measured simply by its effects in facilitating 
the supply of capital in response to the actual demand ; it 
must be measured by its effects in facilitating the supply 
of capital in response to the true social need. The organization 
of the market operates partly on the side of supply, partly on the 
side of demand ; and its work must be taken to include both that 
of reducing the costs at which capital is supplied and also that of 
formulating the social need into an effective market demand. We 
need therefore to take account of the economies effected by the 
market on the side of Demand, and may begin by giving some 
clearer definition of the nature of what has been described as " the 
true social need." 

Any full consideration of the true social demand for new capital, 
i.e. the demand arising not from the wants of individuals but from 
the true needs of society, would require a discussion of the nature 
of social welfare and the manner in which this is affected by the 
distribution of capital among its various uses. It would be 
necessary to examine the total social effects of the employment of 
capital in each direction ; to consider, for example, how much 
must be added to the nominal return on capital employed in the 
construction of new tramways on account of the contribution 
to the health of the population which would result from their 
greater ability to live at a distance from industrial centres ; and how 
much must be subtracted from the nominal return on capital 
devoted to building more breweries, to allow for the additional 
cost of police and the injury to the morale of a part of the consumers 
of the additional supplies of alcohol. An attempt of this kind to 
find the net social contribution of capital in each of its various 
uses and the distribution of the annual supply which would maxi- 
mize this contribution would be far beyond the scope of this chapter. 
For the purpose of the present argument we may disregard the 
indirect social effects resulting from the employment of capital 
and consider the social interest as satisfied by the supply of capital 
to those uses in which its yield of net interest is highest. 


That being so, the sources of the true social demand for capital 
will lie in the opportunities and emergencies arising from time to 
time, and involving, it may be, the foundation of a new enterprise, 
the extension of an old one, a merchanting operation, or the require- 
ments of the State for carrying on war ; and this demand will be 
expressed in each case simply by the set of prospective net returns 
which it offers to the capitalist. As the argument is concerned 
primarily with the supply of capital to business uses, the matter 
may be put more explicitly. Every business opportunity or 
venture has a social title to capital which is based on its prospective 
earning power, and should be supplied with capital in accordance 
with its prospective yield ; accordingly the main question to be 
considered is that of the work done by the market in converting 
this social title into an effective demand. 

The fundamental difficulty in this conversion arises from the 
extreme complexity of the circumstances which determine the 
earning power of any venture. In the social interest, capital 
should be suppUed to industrial ventures in accordance with their 
prospective earning power, but this will occur only if the proper 
risks of these ventures, i.e. the risks as estimated by well-informed 
opinion (cf. p. 88), correspond to the estimate of those risks 
which is formed in the mind of the capitalist. In consequence, 
however, of the complexity of the conditions determining the 
proper risks of any venture, the capitaUst will usually be quite 
unable to form any accurate estimate of their importance ; accord- 
ingly, when supplying capital in response to a demand of this kind, 
he will do so not in accordance with the proper risks of the venture, 
but in accordance with the estimate of those risks which he forms 
in the Hght of his imperfect knowledge. Let us put the matter a 
little more fully. The social demand for capital arising from any 
venture depends upon its prospective earning power, but the 
effective demand arising from that venture depends upon the 
distorted image of that earning power which is thrown on the mind 
of the capitalist. The imperfect knowledge of the capitalist acts 
as a kind of refracting medium which may magnify risks so greatly 
that no supply is forthcoming, or may contract them so that 
capital is suppUed to ventures with no social title to it ; in either 
case it prevents the flow of capital into industrial undertakings 
simply in accordance with the social interest, that is to say, in 
accordance with the set of prospective net returns which they 

There is then this gap between the sources of demand 
and supply ; it is due simply to imperfect knowledge and con- 
stitutes a kind of " economic distance " which it is the function 
of the market to bridge. Where capital and business power are 


in the same hands the gap does not exist ; where they are closely 
aUied by business or personal connexions it may be small and 
capital will flow readily across it, as when a merchant grants trade 
credit to a retailer or when a business man borrows from his friends ; 
but where a new undertaking comes into the market to obtain 
capital from the public, the gap is very wide and capital can be 
forced across it, as an electric current is made to pass a gap between 
its terminals, only with great noise and waste. 

In formulating the social title of business opportunities into an 
effective demand for capital two devices are important : the first 
consists in the offer of security, the second in the establishment 
of some intermediate organization which investigates the claim 
of the venture and, in effect, presents that claim to the public 
supported by its own guarantee. We may consider these two 
devices in order. 

The demand for capital presented by any business man in- 
cludes two kinds of risk, the industrial risks arising from the un- 
certain efficiency of his undertaking, i.e. its ability to supply a 
product of greater market value than the sum of its expenses, 
and the personal risks arising from the possibihty of some defect 
in Ms own business integrity. The distinction is an important one, 
for it brings out the function of the security in converting pro- 
spective earning power into a market demand. 

Let us take first the case of a business man who offers as 
security for a loan only the prospective earning power of his under- 
taking. The capitahst who meets this demand must expose his 
capital to both personal and industrial risks, and the price at which 
he will supply that capital will depend on his necessarily vague 
estimate of the amount of that twofold risk. A demand of this 
kind may then be entirely ineffective ; in any case it is likely to 
call forth a supply of capital only at a price which is much higher 
than that appropriate to the proper risks of the undertaking. One 
practical consequence of this is that such a business is handicapped 
in its competition with those which own their own capital. 

Let us now contrast this with a similar case in which the busi- 
ness man is able to support his demand with the offer of adequate 
security. The terms of the loan contract may vary widely, but we 
may take a typical case to be that of a well-secured advance ob- 
tained on mortgage. In these circumstances both personal and 
industrial risks are automatically shifted from the party supply- 
ing the capital to the party employing it. Accordingly the per- 
sonal risks cease to exist, for the business man cannot profitably 
defraud himself ; and the deterrent effect of the industrial risks 
is greatly reduced, for they are borne by the party who can most 
accurately estimate their importance and devise measures to meet 


them. A demand of this kind, then, is hkely to call forth a supply 
of capital at a price which conforms closely to the industrial riste 
proper to the undertaking ; and an enterprise obtaining its capital 
in this way is handicapped in its competition with other imder- 
takings employing their own capital by httle more than the legal 
charges involved in the preparation of the security against which 
the capital is supplied. We may conclude then that the security, 
by eUminating personal risks and most of those due to imperfect 
knowledge on the part of the capitalist, plays an important part 
in enabling the social demand for business capital to become 
effective in the market. 

If the security is important in the formulation of the demand 
for capital, it follows that the movement of capital into its most 
productive uses depends to a considerable extent on the forms 
in which the property of a country is held, its distribution among 
the population and the law determining the manner in which 
it may be charged as security. That part of property which is 
most influential in this way is probably the wealth invested in the 
negotiable securities dealt in on the Stock Exchanges. It is 
estimated that in Germany in 1907 26 one-third of the total wealth 
was invested in this way ; in France the proportion is rather 
larger ; in England it may well be Icirger still. These securities are 
very widely distributed and readily pledged ; their influence on 
the mobihty of capital must be of the first importance. 

Immobilia such as land and buildings are extensively used in 
support of demands for capital in France ; for example, they are 
employed as security for loans amounting to £560 m. But the 
internal demands arising in this way in England are not in general 
formulated by any special market organization as is the case on 
the Continent. Such banks as the Credit Foncier,27 for example, 
obtain capital by the issue of their own bonds and lend it against 
mortgages and similar securities ; in other words, they collect 
that part of the pubhc demand which is backed by a miscellaneous 
and unmarketable aggregate of charges and convert it into an 
effective demand in the pubUc market expressed in terms of a 
homogeneous issue of marketable bonds. The operations of such 
a bank may evidently introduce an important economy ; for the 
work done by hundreds of solicitors is unified in a single institution ; 
and the capitahst, inasmuch as he holds a marketable bond, can 
recover the value of his investment at will without disturbing the 
party to whom his capital has been suppHed. 

In addition to such material forms is the security afforded by 
the business reputation and wealth which constitute the credit of 
the borrower. But the trustworthiness of business men is in- 
effective as a power to borrow until it is recognized by those with 


capital to lend. The banks are in intimate contact with practically 
every business man in the country ; and the information which 
they acquire, supplemented by the work of inquiry agents such as 
Perry's or Stubbs' and by the personal contact of business men in 
the great financial centres, is diffused throughout the entire business 
community. Perhaps the most important part of the work done 
by the Money Market in promoting the mobility of capital lies in 
this diffusion of information by which business reputation is made 
effective as a power to borrow. The support of brokers, financiers 
and underwriters to the flotation of a new issue is generally de- 
pendent less on the actual prospects of the undertaking, as to 
which they can know little, than on the reputation of its sponsors.28 
Bankers are greatly influenced, even when making well-secured 
loans, by their opinion of the borrower, for they are naturally 
reluctant to recover an advance by realizing the collateral de- 
posited by their customer ; some (jerman bankers even maintain 
that the unsecured is safer than the secured loan. The bill of 
exchange, one of the most powerful instruments for promoting 
the mobility of capital, depends for its successful operation upon 
the diffusion of information through banks and inquiry agents of 
the solvency of the parties who have put their names on it. 

As is well known, the use of the personal guarantee in the Scotch 
" cash credit " system converts the potential demand of capable 
business men into an effective means of obtaining capital from the 
banks. 89 In England, too, this method is extensively used; the 
directors of a joint-stock company, for instance, may give their 
guarantee in support of a loan from the company's bankers, thereby 
avoiding the issue of debentures and the consequent pubHcation 
of the fact that the company is borrowing. The collective personal 
guarantee, organized by special banks, is the means by which many 
hundreds of thousands of peasants and small producers on the 
Continent obtain from the public the capital they require to carry 
out their agricultural and industrial operations. Business reputa- 
tion is sometimes the sole means by which the small retailer obtains 
so much as one-half of his capital from a wholesale dealer ; and it is 
the principal means by which the English banks borrow some £840 m. 
from the public. 

There is no need to enter into a lengthy examination of the 
various forms of material and immaterial wealth which business 
men may use in support of their demands for capital. This brief 
discussion of the three principal forms is sufiicient to show their 
great importance in reducing " economic distance " and facilitating 
the movement of capital into its various uses. It shows too — what 
is indeed obvious enough — that the mobihty, and, therefore, the 
productivity, of the capital of a country depend largely on the wide 


distribution of forms of material wealth and on the reputation of 
its business men. Our vast war loans, by reason of their wide dis- 
tribution among the population in the form of readily pledged 
securities, are likely at least to make some contribution to this end. 

The influence of the law in creating and perfecting the various 
forms of security is far too large a subject to be discussed here in any 
detail ; it must suffice to give one or two instances which illustrate 
its effects. Perhaps the most striking example of the effects of 
legal enactment in promoting the mobihty of capital follows from 
the provisions of the long series of Companies Acts which have 
gradually developed the present very convenient procedure for the 
formation of the public Joint-Stock Company. The legal procedure 
laid down in these Acts enables, inter alia, a. business opportunity 
— a merely potential source of earnings — to be embodied in the form 
of negotiable titles to property and presented on the market as an 
effective demand for capital. The essential parts of the operation 
by which this potential demand is formulated are these. In the 
first place, some source of earning power, which may be an invention, 
a concession or other venture, is investigated by a promoting 
group who capitalize it at their discretion and sell it to a company 
formed to acquire and develop it. The capital of the company so 
determined is then embodied in the form of shares, each one of 
which entitles the holder to a defined portion of the property 
and earnings of the company, while involving him in no HabiHty 
beyond its face value for any Uabilities which the company may 
incur. Finally, these shares are sold to the pubUc by means of the 
machinery of the market. This very convenient procedure enabhng 
a pubHc company to obtain the capital it needs is supplemented 
by another provision which gives it a further advantage over the 
private business man ; for while in general a large part of the property 
of the private trader cannot be charged in any satisfactory way as 
security for a loan, the law enables the joint -stock company to 
employ the whole of its assets, even its book debts, as a basis of 
borrowing power, charging them by means of debentures, which may 
be deposited with a bank as security for an advance or sold to the 
pubHc in the open market. It is evident, therefore, that the legal 
machinery created by the Companies Acts is a very powerful means 
by which any latent source of earning power may attract to itself 
the capital requisite for its development ; practical evidence is 
given by the fact that each year several hundreds of new public 
companies are formed to acquire existing undertakings or develop 
new business opportunities at home or abroad. 

The Acts relating to Companies show the power of the law to 
create a security ; those regulating the Credit Foncier and many 
other mortgage banks give an instance of the manner in which the 


law may perfect a security and so make it more effective as a means 
of attracting capital. The work of the Credit Foncier, for example, 
in suppl3dng capital to landowners against mortgage of their pro- 
perty is greatly facilitated by an important legal privilege known as 
the " purge." 30 jj^^g bank, having assured itself that there are no 
registered claims on the property against which it proposes to lend, 
issues a brief official notice calling on third parties to make known 
any rights which they may possess in respect of the property in 
question. If no hidden claims are disclosed within a period of about 
three weeks, the bank may safely proceed to lend against a mortgage 
of the property, for its special legal privilege makes its title to the 
property incontestable by any claims which may subsequently be 
brought forward. A legal provision of this kind evidently reduces 
in a marked degree the labour and risks of the bank's work and so 
lowers the supply price at which capital may be provided against 
this form of security. Some measure of the economy is given by 
the heavy legal charges which must be incurred in England in 
investigating the title of the property to be charged with a mortgage 
as security for a loan. The great practical importance of State 
action in creating and perfecting forms of security is very evident 
at the end of 1920, when the League of Nations is advocating the 
adoption of two plans of this kind, each designed to promote the 
flow of capital into countries whose demand for it is urgent but 
largely ineffective. 

The first important method by which the social title to capital 
is formulated lies then in the device of the security. The employ- 
ment of a security in support of a demand for a loan destroys the 
personal risks and shifts the business risks, in part at least, on to the 
borrower, whose interest it then becomes to reduce them to a 
minimum. It bridges the economic distance separating borrower 
and lender, for it partly destroys the effects of ignorance on the part 
of the lender in distorting his estimate of the risks of the loan, and 
so enables capital to flow more readily to the points of highest jdeld. 
The mobility of capital in any country largely depends, therefore, 
on the forms in which property is held, especially on the holding 
of Stock Exchange securities and, if we choose to reckon this as a 
kind of security, on the reputation of its business men ; it depends 
also on the wide distribution of these forms of property among 
the people. The various forms of security may be developed by 
the market, in particular by such organizations as land mortgage 
institutions and the multitude of people's banks formed on the 
Continent. Their efficiency in supporting a demand for capital is 
naturally affected by the whole body of property law ; and 
they may be created and perfected by such special legal 
enactments as the Acts relating to the formation of companies 


and the negotiation and rights of recourse in respect of bills of 

We turn now to the second method by which the demand for 
capital is formulated. 

That part of the demand for capital which arises from the need 
to float new undertakings by means of capital obtained from the 
pubUc market cannot usually be supported by the offer of security. 
Such a demand must rest almost entirely on prospective earning 
power, and can be effective only in so far as it can convince the pubUc 
of the worth of these prospects. It is evident, however, that the 
difficulty of making out a good case is very great ; for an estimate of 
the earning power of a new venture and the integrity of its manage- 
ment is a matter which requires intimate and expert knowledge ; 
and as the public can have little or no independent information on 
either point, supply will be regulated not by the proper risks of the 
venture but by the distorted image of those risks resulting from the 
imperfect knowledge of the capitaUst. This imperfect knowledge 
will in some cases magnify risks and cause capital to be withheld 
from useful enterprises, and in other cases diminish the estimation 
of risk and so cause capital to flow into the hands of fraudulent 
company promoters and into ventures with no reasonable prospect 
of success. Accordingly in the flotation of new enterprises on the 
market, and even in the conversion or expansion of existing under- 
takings, there is a good prima facie case for the interposition of 
some expert, responsible body which could examine impartially the 
prospects of the venture and, if suitable, present it to the public 
with the impUcit guarantee that the enterprise was one with a 
reasonable claim to the capital for which it asked. Such a 
body, lending its reputation in support of a demand for capital, 
would perform a social function similar to that of an Accepting 

In Germany, as is well known, this function is performed to 
a considerable extent by the great credit banks. For example, 
groups of these banks stand behind the mining and electric industries; 
they have an intimate knowledge of the earning power of the 
undertakings in which they are interested, and they sell the shares 
and bonds of these undertakings to the pubUc with their assurance 
that the securities carry with them a reasonable prospect of dividends. 
In France, too, industrial securities are marketed largely by bankers 
who, in effect, pledge their reputation on the soundness of the 
securities which they offer to their customers. Such operations 
can be effectively carried out only with very special knowledge 
and experience and, even then, they may react unfavourably on 
the other branches of the banks' work. But the results achieved 
seem to show that such organizations can do very valuable work 


in bridging the gap between capital and the opportunities for its 
profitable employment. 

In England the position is very different. An industrial enter- 
prise which requires to obtain its capital from the pubUc must 
usually present its case without the aid of any well-known inter- 
mediary. This may be fairly satisfactory when the public have 
some means of estimating the genuineness of its demands ; for 
example, a textile factory of good reputation may easily obtain 
increased suppUes of capital locally by the issue of debentures, and a 
well-known undertaking whose earning power is proved may come 
to the London market and without much difficulty sell itself to 
the public as a joint-stock company ; but it is quite another matter 
when an industrial venture of which the public know little or nothing 
comes to the London market for the supply of capital it needs in 
order to start business. 

The demand of such a venture is probably formulated by a 
little ad hoc promoting group who state their case in the form of 
a prospectus with all the ingenuity and optimism which the law 
allows, distribute these prospectuses far and wide and generally 
insure their prospects of obtaining a minimum supply of capital 
by underwriting their issues at a heavy cost. This demand is based 
on a set of industrial circumstances so complex that without expert 
investigation any opinion is worthless ; and it is put forward by 
interested parties practically unsupported by any independent 
recommendation. Whether or no the venture has any social title 
to be supplied with capital, it seems clear that a demand so formu- 
lated could not carry conviction of this title to any reasonable 
person. With such market machinery, therefore, the prospective 
earning power of any venture is only very imperfectly converted 
into an effective demand. Good and bad ventures are almost 
indistinguishable and capital is suppHed to both wastefully and at 

We have, then, the following conclusions with regard to the 
demand for new business capital. In the social interest capital 
should flow into business ventures in accordance with their pro- 
spective earning power ; accordingly, the social demand for capital 
is expressed simply by the prospective earning power of industrial 
ventures of all kinds. In this simple form it must be in a great 
measure ineffective ; for the proper risks of the venture are 
increased in the view of the capitalist by his imperfect knowledge 
of the economic efficiency of the venture and by the possibiHty of 
fraud on the part of the borrower. The " economic distance *' 
caused by these additional risks is small when lender and borrower 
are in close touch, but widens as the two parties have less knowledge 
of one another and is at its maximum when a new undertaking is 


endeavouring to obtain its capital in the public market. On the 
side of demand the gap is bridged to a very great extent by security 
and business reputation ; but this device cannot usually be employed 
in the flotation of undertakings on the pubhc market ; hence the 
case for some intermediate marketing organization which would 
be responsible for these issues. In other coimtries the work done 
by the market in formulating demand is in many respects more 
complete than in England. But no very definite conclusions can 
be drawn from this fact, as the organization of the money market 
appropriate to any coimtry necessarily depends on its general 
social conditions. It seems probable that in England the most 
important consideration affecting the form of this part of the 
market organization has been the wealth of its population, which 
has enabled business men to obtain their suppUes of capital in a 
great measure from other parties associated with them by business 
or personal relations. 


SO far the argument has been concerned with the influences 
which check the flow of capital towards the points of highest 
net return ; it has accordingly dealt on the one hand with 
the cost of production of capital and on the other with the 
difficulties involved in the effective formulation of Demand ; but 
it has treated only in an incidental way the effect of the work done ^ 
by the individual market agencies in reducing these costs. It 
needs, therefore, to be supplemented by a review of the work done 
by each of these agencies, designed to bring out the nature of the 
economy effected by each. It should be noticed that in this 
preliminary review the Banks, the Market for Negotiable Securities 
and Trade Credit are not dealt with on a scale at all proportionate 
to their importance, for they receive separate treatment in later 
chapters. It may be noticed, too, that no attempt will be made 
to confine the meaning of the term " marketing " within the narrow 
limits previously defined ; its meaning must be derived from its 
context ; but usually it will be used in the ordinary business sense, 
that is to say, it will refer to the whole work of management of 
capital, and will consequently include all the work done in reducing 
risks and estabhshing business contact between the parties who 
supply capital and those who employ it. 

In order that the situation with which we are concerned may be 
quite clear it may be well to recall the general conditions which 
form the setting of the work to be reviewed. On the one hand is 
the group of capitaHsts, which includes all those who have available 
supplies of free capital ; on the other hand is the group of business 
men and others, including all those who employ capital ; between 
the two lies the Money Market, facilitating the movement from one 
group to the other of the stream of free capital seeking investment, 
or rather of that part of it which is not applied directly by its owners 
in maintaining and extending their businesses. The market 
facilitates the transfer of this stream of free capital, partly by lower- 
ing the costs of supply, partly by assisting in the formulation of 
the demand. We have to distinguish the nature of the economy 
effected by each of the agencies forming the market. 


The Banking System 

The most prominent part of the market organization dealing 
with the supply of capital for short periods is undoubtedly the banks, 
including in that term, not the Foreign and Colonial institutions 
whose work lies mainly abroad, or firms such as Higginson or Morgan 
who are concerned mainly with the issue of securities, but the 
typically EngUsh banking system headed by the Bank of England 
and generally, though not very accurately, described as the Joint- 
Stock Banks. 

These banks, though economically intermediaries or middle- 
men, are legally principals ; they do not merely assist the capitalist, 
but take from him, and assume themselves, the entire work of 
management of his disposable capital. JThey have set up, in 
England and Wales, an elaborate and higJily centraUzed organiza- 
tion of some 50oo_brancli£ means of which they establish direct 
business contact with very large numbers of people who have, and 
people who need, capital. This system of branches enables them, 
by the offer of a rate of interest or of cheque-making facilities, to 
collect from the public many thousands of small items of capital 
amounting in the aggregate (in 1914) to some £840 m. The central- 
ized character of this system enables them to pool these items very 
effectively and to make a large part of the aggregate available for 
loans to the business men with whom their branch system places 
them in immediate contact. Add to the economies due to this 
organization those arising from the facts that they are expert dealers 
in capital and also principals whose profits depend on the reduc- 
tion of risk and expenses of marketing, and it becomes evident 
that their operations have a very powerful effect in lowering the 
supply price of capital for temporary business uses. > 

The Devonshire farmer is hardly likely to undertake himself 
the work of lending in Lancashire a small quantity of capital 
which he can temporarily spare ; and if he did so he would naturally 
require a very high return to compensate him for the trouble of 
finding a borrower, for the heavy risks due to his imperfect know- 
ledge and for the insecurity which he would suffer from his inability 
to recover his capital on demand in order^-to meet any business 
emergency to which he might be exposed, '^ith the interposition 
of the banks, however, the capitalist with a little capital tem- 
porarily free, is enabled to obtain interest upon it at a rate of 
perhaps 2^ per cent per annum practically without trouble, risk 
or insecurity ; while the capital which he suppUes, pooled in a 
larger aggregate, is transferred cheaply and rapidly from one 
point to another in accordance with the seasonal demands of trade 
and industry, and is suppUed to one remote borrower after another 


at rates exceeding that paid to the capitaUst by, perhaps, only 
I J per cent or 2 per cent. 

Trade Credit 

[In the outer market Trade Credit is the means by which a 
very large aggregate amount of capital is supplied for short periods 
for business uses. ^ This part of the market organization is in a 
great measure bound up with the ordinary work of the merchant 
or dealer. It gives rise to no peculiar economies such as those 
produced by the banks, but it lowers the supply price of capital?/ 
to many business men who would, in its absence, find it difficult,]/ 
if not impossible, to obtain supplies elsewhere. \There can be 
little doubt, for example, that the supply of small tradesmen 
coming into being is in a great measure dependent on the merchant 
who p rovides the m, o n credit, with_a. large _ proportion ol-the. 
I}^£^':'^/^-Ty ^tnr.k, and that many 9,ma]] farmpr^^ p re enabled to tide. 

Qyer_badJiiQ£a-with, thp assis t an r e o f th£_iieakiL3Kha makeaJhsHL 
cash advances on their growing croi3§.jQ.r-auppli£S^tJiem with seeds^ 
f ertilizers and so on for payment at a later date- 

These merchants and dealers must in general supply capital 
without security of the kind which would be required by banks 
and most other lenders. Their special business knowledge of 
the character and means of the parties to whom they grant trade 
credit reduces their risks and gives them special facilities for 
financing this class of borrower ; but it is only to be expected 
that the terms on which they lend should be somewhat onerous. 
These terms may be expressed simply as a rate of interest on money 
lent, or in the form of a scale of prices for goods supphed, which 
increases as the date of payment for the goods is more remote ; 
but they frequently carry with them implicit restrictions which 
may considerably increase their burden. For example, the com- 
petition of merchants for the custom of retailers sometimes ex- 
presses itself hi the form of an extension of trade credit, of an 
offer of more easy terms of payment for goods supplied, an offer 
which enables the merchant to establish his trade connexions 
more firmly, but imposes on the retailer a limitation of the sources 
from which he can buy his goods and may place him substantially 
in the position of a " tied house." Again, the dealer who in one 
way or another finances the small farmer will often do so on the 
understanding that the farmer's crops shall be sold only to him. 
In such cases the farmer is supplied with capital secretly, a dubious 
but apparently highly prized advantage, and the loan may be 
made at a low nominal rate ; but the true rate may be, and often 
is, high, for it depends on the price at which the farmer sells his 


produce, a price which rests largely with the dealer who has supplied 
him with capital. 

The main characteristics of trade credit as a means of supplying 
capital appear then to be these : by its means a class of borrowers 
who often can offer little or no security except their character 
and business record are enabled to obtain suppUes of capital for 
short periods from lenders who have special knowledge of their 
trustworthiness and business circumstances ; it is the means, 
therefore, by which many retailers are enabled to set up and main- 
tain independent businesses and by which business men in general 
are often enabled to tide over temporary emergencies. Being 
employed, however, in the competition for custom, trade credit 
may be unduly extended and result in capital being lent recklessly 
and irrecoverably, clear instances of this being seen in German 
pre-war trade with Japan, South America and other countries. 
At the same time the supply of capital by this means is often 
accompanied by restrictions which limit the freedom of the 
borrower to buy and sell where he chooses, thereby placing him 
in a less or greater degree at the mercy of his creditor and making 
the terms of the loan dependent largely on the will of the lender. 
Trade Credit, therefore, as an agency for the supply of capital has 
considerable social importance ; but, perhaps, its main interest 
and certainly its greatest difficulty Ues in its effect on prices, in 
the influence of changes in the purchasing power granted by way 
of trade credit in causing fluctuations in the general level of prices. 
These influences are discussed in a later chapter. 

The Market formed by Solicitors 

The outer market includes also another important organiza- 
tion for the transfer of capital — the series of local markets in which 
solicitors convey capital to business men and other parties who 
are able to offer as security such property as land and buildings 
which may be subjected to a mortgage or similar charge. 

The total amount of capital lent against the mortgage of land 
and buildings in France is known to have been about £560 m. in 
1908, while in Germany at about the same date the amount lent 
to landowners on mortgage and other real estate security is 
estimated rouglily at £2000 m.^i These figures suggest that this 
part of the market for capital is Hkely to be of considerable import- 
ance in England ; indeed, there can be no doubt that large amounts 
of capital are supplied through this organization, but it seems 
to be quite impossible to form any definite estimate of its amount. 
Mr. A. L. Cox in a paper read to the Surveyors' Institute writes : 
"... the properties that have never been mortgaged are few and 


far between. ... It is impossible to indicate with accuracy the 
total amount loaned on mortgage of real estate in the United King- 
dom, but pubHshed accounts show that insurance companies and 
building societies have more than £150 m. on loan." Again, 
Mr. J. J. Done in a paper read before the same Institute 
states : ** An enormous amount of money is advanced every year 
on suburban house property. ... I strongly suspect that the 
majority, perhaps the large majority, of suburban houses have a 
mortgage on them." ^2 While in the opinion of " a sohcitor 
of great abiUty and experience " probably more than three-quarters 
of the land and buildings in the country are subject to some form 
of mortgage. When it is remembered that the aggregate pre-war 
value of the land and buildings of the United Kingdom was in the 
neighbourhood of £4500 m. some rough idea may be formed of 
the volume of capital supplied through the agency of solicitors. 

The capital supplied in this way is evidently lent in the main 
for long periods, though it must not be overlooked that bankers 
lend considerable sums temporarily against mortgage securities. 
It appears to be supphed principally for business purposes and, 
as most undertakings possess property which may be subjected 
to a mortgage, must be an important source of supply of business 

But there are evidently particular classes of borrowers to whom 
this method of supply will be of especial importance ; for example, 
" The corporations of many of the larger towns, especially in the 
manufacturing districts, borrow extensively upon short period 
mortgages. Tradesmen and others who are getting on well in 
business call at the office of the town clerk or borough treasurer 
when they have a little money to invest, and generally find no 
difficulty in placing it on loan with the corporation." ^3 

More interesting among these particular classes, however, are 
landowners and business men who produce very durable goods. 
The use of the mortgage in drawing capital into agriculture for the 
construction of permanent improvements is too well recognized 
to need discussion. Its use is not less important in building opera- 
tions ; it is stated, by experienced solicitors, for example, that 
considerably more than one-half of the new buildings coming 
into being are financed partly or wholly by loans on mortgage. 

This method of supplying capital against mortgage can hardly 
be less important in the shipbuilding industry. In the Wear 
district " in normal times the ships are mortgaged to the Ship- 
builder and the mortgage paid off, either by earnings only, or in 
some cases by instalments in addition to earnings. . . . Builders 
frequently built and dehvered ships costing £25,000 to £40,000 
on a deposit of £4000 to £6000." Again, on the Clyde and Tyne, 


" the financial arrangements between the Shipbuilder and his 
customer in practice vary strictly in accordance with the demand 
for sliips. In very slack times Shipbuilders have almost made 
themselves Moneylenders, agreeing to accept 50 per cent and some- 
times as little as 10 per cent, spread over the period of the building, 
allowing the remainder to He over for payment during perhaps 
from three to six years. In these circumstances, the ships are 
mortgaged to the Shipbuilder and the mortgages are paid off from 
later earnings. ... On the contrary, however, when trade is good 
and there is a great demand for ships, the Shipbuilder is able to 
stiffen his back and have his payments made in the form of instal- 
ments during building." ^ 

These examples are causing the argument to drift away some- 
what from the local market for capital formed by soHcitors into 
the region of Trade Credit ; if they were extended to illustrate 
the work done by sohcitors in assisting joint-stock companies of 
all kinds to borrow on the security of debentures, they would lead 
away still further into the work of the securities market ; for there 
is no clear line of division between these various markets ; the 
operations of each shade off imperceptibly into those of the others. 

The economic function carried out by the solicitor who forms 
a local market for capital is a simple one. He may reUeve the 
investor of marketing work by placing him in contact with a suitable 
borrower, in which case he receives an additional fee ; otherwise 
his function is to reduce risks by investigating the security and 
casting the loan contract into its appropriate legal form. 

In France and Germany this part of the market is more highly 
organized by the establishment of Mortgage banks, whose operations 
yield an additional economy over and above those arising from the 
work of the English solicitor ; for while the mortgagor in England 
can recover his capital only at end of a fixed period of supply, i.e. 
when the mortgage " falls in," or by the troublesome process of 
transferring his mortgage to some other party, the mortgagor 
abroad can sell his security on an organized market at any moment 
w^en his particular business circumstances make this desirable. 
'The manner in which the Mortgage banks reduce the Insecurity of 
^e investor in this way is somewhat as follow^s : they lend large 
amounts of capital, usually for very long periods, on such securities 
as mortgages and municipal bonds, and obtain this capital from the 
pubHc by the issue of a homogeneous mass of their own bonds 
secured on the mortgages and bonds against which they lend ; 
accordingly the member of the pubhc who supplies capital against 
mortgage security through the agency of these banks obtains, not 
as in England a security merely entitling him to repayment at a fixed 
date, but a security which he can reahze at any moment he chooses 


by sale in a public market. The operations of these banks in reducing 
the Insecurity attaching to the supply of capital for very long 
periods effects therefore an important economy. As an illus- 
tration of the wide scope of their operations it may be noticed that 
in 1907 forty-one Mortgage banks in Germany had outstanding 
loans on mortgage to an amount exceeding £460 m. The opera- 
tions of these German banks are of course far from covering the 
whole field ; large amounts of capital are supplied by Savings banks 
against mortgages, while it is estimated that 80 per cent of the 
premium reserves of Insurance companies are similarly invested, 
in addition to some £1000 m. supplied by private mortgagors.^s 
Possibly one reason for the absence of these banks in England is 
the ample supply of capital and the fact that much of the capital 
conveyed by solicitors in this country against mortgage security 
consists of the funds of such parties as trustees who prefer to invest 
it for long periods and consequently attach little value to the 
opportunity to recover it at will. 

Trust and Finance Companies 

Among the specialized institutions forming the Money Market 
proper are the Financial Trusts and the Financial, Land and Invest^_ 
noent. Companies,, a group jiL^averal. hundr£ds„QlxQmpames..con- 
t rolling capitalof a nominal value of some^£35o m. supplied by the 
jpublic_partly against shares partly against issues of debentures. 

There are certain general differences between these two groups 
of agencies : Dr. Weber points out, for example, that the shares of 
the Financial, Land and Investment companies are more specu- 
lative in character, while Mr. E. T. Powell notes that these com- 
panies lend for shorter periods than the Trusts. But there seems 
to be no clear line of demarcation between their functions, so that 
it is convenient to deal with them as a single group. The individual 
companies forming this group differ considerably in their general 
character, ranging from the highly reputable Trust company 
proper, mainly concerned in carrying on a conservative investment 
business, to financial houses engaged in speculative operations of 
a most varied kind ; their field of worXlies to some extent in the 
United Kingdom, biil-mainly. it would seem, in foreig n_£ ountii£Sv 

The purposes for which they are formed are very numerous. 
Among the objects of companies operating mainly at home are 
these : to invest funds ; to discount bills ; to lend on approved 
securities, on mortgage of land and on house and shop property, 
etc. ; to deal in land and houses ; to acquire and develop property ; 
to develop and assist commercial undertakings ; to underwrite 
issues of securities and to convert businesses into joint-stock 


companies ; to receive deposits ; to purchase assets of insolvent 
estates ; and to carry on business as trustees and agents; The 
companies operating mainly abroad are even more varied in their 
objects. They are formed to invest in United States securities, 
in Canadian real estate mortgages, in railway bonds, in telegraph 
companies, and in rubber, tea and coffee plantations ; to lend 
against mining securities and on land, stations, Uve stock and 
wool in Australia ; to carry on a banking business ; to deal in oil 
companies, in options and mining claims in Alaska ; to assist 
industrial development in Mexico ; to promote and invest in rubber 
companies, to employ capital in South Africa in the issue and pro- 
motion of financial and other undertakings, to act as an Issue House 
for Government, Municipal and other loans ; to acquire freehold 
land, to acquire and work railways ; to provide an organization 
whereby existing stocks may be converted into more than one 
class of security ; to finance a prospecting and exploration com- 
pany, to carry on general financial business, to act as agents, 
trustees, etc. 

The great variety of the purposes for which these companies 
are formed tends rather to obscure the true nature of their work. 
But it will be noticed that nearly all their operations centre round 
one principal function — that of suppljdng capital. ''Essentially 
they are expert investment agencies, on the one hand collecting 
capital from the public and on the other supplying it in many 
different ways and to many different employments at home and 
abroad. They may supply it by way of loan or investment, by 
the promotion of new ventures or by undertaking themselves the 
administration of some business enterprise ; in every case they 
take over from the investor practically the whole work of manage- 
ment of his capital and increase its yield by their expert knowledge 
of the field of investment. 

This substitution of expert investment agencies for the ill- 
informed operations of the investor naturally faciUtates the move- 
ment of capital towards the points of highest yield, and so increases 
its productivity. It has the effect, in the first place, of widening 
immensely the field of employment of capital, for it would clearly 
be out of the question for the average investor to attempt to lend 
against mortgages of real estate in the United States or to wool- 
producers in Austraha. Again, as each company controls the 
capital of many individual investors it is enabled to spread its risks 
by selecting a wide range of investments ; a Trust company may, for 
example, hold as many as two to five hundred different kinds of 
securities whose fluctuating dividends set off one another and enable 
the company to pay its own shareholders a good and steady return. 
A further advantage is the abihty of these companies by underwriting 


new issues to obtain sound securities at a price lower, and often much 
lower, than they are offered to the pubhc. Their special knowledge 
enables them also to add to their profits by speculative dealings in 
stocks and shares and other forms of property ; in its more con- 
servative aspects this work takes the form of buying securities whose 
values are temporarily depressed or of selling those whose values are 
temporarily inflated, " undoing " the deal at a profit when these 
values have again recovered their normal level. Sir Robert Giffen 
has pointed out the great social advantage of operations of this kind ; 
for the continuous shifting of large amounts of capital from one 
security to another under expert speculative control is an element 
of great strength in a market, protecting it, in part at least, from 
violent upward and downward movements in the prices of securities 
which are unjustified by changes in their prospective yield. 

In addition to the important economies effected by Trust and 
Investment companies in this way is the influence of their work in 
financing and administering new undertakings and of their other 
miscellaneous services. 

Some of these companies undertake the flotation of new under- 
takings operating in England and the marketing of securities on 
behalf of such parties as foreign States who wish to obtain supplies 
of capital from the English public ; but this kind of work cannot be 
regarded as typical of the group as a whole. The comment applies 
with less force to their foreign work ; for many British undertakings 
operating abroad in the production of rubber, the development of 
gold mines and in less speculative enterprises have been formed by 
these companies, who supply them with capital either directly from 
their own resources or indirectly by undertaking the sale of their 
shares and debentures on the London market. 

Many of these companies themselves administer the capital at 
their disposal and undertake pioneer and development work in all 
parts of the world. They may be formed to encourage irrigation in 
Mexico, to assist in financing and developing peat coal deposits or to 
acquire and work a railway ; one company owns land in Argentina, 
another owns a large number of farms in South Africa, another a con- 
cession in Egypt. Side by side with this work of development are 
the salvage operations undertaken by companies formed to take 
over the assets of insolvent estates or of undertakings which 
find themselves in difficulties. This salvage work, according to 
Mr. E. T. Powell, is " very important and characteristic." 

Regarded broadly, the nature of the work done by these com- 
panies seems to be midway between that of the banks and that of 
the market for new negotiable securities. They resemble the banks 
in their operations, inasmuch as they take over from the public the 
work of management of the capital entrusted to them, administer 


it as principals and depend for their profits on their success in carry- 
ing it to the points of highest return. But their work is more nearly 
akin to that of the securities market in that it is concerned with the 
supply of capital for long periods of time, and in so far as it consists 
in the issue of new stocks and shares must be reckoned as forming a 
part of that market. As a broad generalization it may perhaps be 
said that their typical service lies in supplying capital for the more 
speculative kinds of industrial enterprise mainly in foreign countries. 
Mr. Goschen bore witness to the effectiveness of their work in carry- 
ing capital abroad when he maintained in his " Seven per cent " 
that their operations were one of the principal causes of the exception- 
ally high rate of interest prevaiHng in 1864. 

The Market for Stock Exchange Securities 

The Market for Negotiable Securities forms the principal 
organization dealing with the supply of capital for long periods; 
it provides facilities, it is true, for obtaining from the public com- 
paratively short loans against such securities as Treasury bills and 
short dated American railway bonds, but its main work lies in 
facilitating the provision of capital for long and even indefinite 
periods of time. Its operations are largely international in character, 
and have been the principal means by which this country had 
invested, by 1911, some £3000 m. in State and Municipal loans, 
railways and other undertakings in countries abroad. That figure 
indicates only partially the vast scope of its work ; so long ago as 
1900 the countries of Europe owned £13,000 m. in negotiable 
securities, and were buying new securities through the agency of 
their various markets at an annual rate of more than £400 m.^' 

The EngUsh securities market resembles the banking system in 
the fundamental nature of its operations ; each has for its function 
the work of faciUtating the movement of capital into its most profit- 
able uses ; and this similarity extends further than is apparent at 
first sight, for, as will presently be seen, the economies to which 
each organization gives rise are identical in their essential character. 
There is, however, a wide difference between the two in the extent 
to which they relieve the investor of the work of management of his 
capital. The banks are principals ; they own the capital which 
they obtain from the pubHc, and consequently assume the entire 
responsibiUty for the risks and labour of its investment. The 
securities market, on the other hand, acts in an advisory rather than 
an executive capacity. From this there arise important differences 
in the social effects produced by the two kinds of organization. 
The profits of the banks depend directly upon the wise admini- 
stration of the resources entrusted to them by the pubUc ; their 


interest and the interest of society alike depend upon their carry- 
ing the capital at their disposal to the points of highest yield. But 
the profits of the Issue House and the company promoter are not in 
general directly dependent upon the most effective distribution of 
the capital supplied by the public ; they are so dependent only so far 
as their reputation is bound up with the wise investment of capital 
and suffers if they facilitate the movement of capital into uses which 
do not yield a reasonable return. There is not, therefore, an identity 
of private and social interest in the work of the securities market ; 
the natural social safeguard does not exist here as it does in the work 
of the banks ; hence much capital supplied by the public through 
the agency of the market for negotiable securities passes into em- 
ployments which offer no reasonable prospect of adequate return 
and is partially or wholly lost. 

The securities market consists of two parts, each distinct in 
function but jointly contributing to the common end of facilitating 
the transfer of capital into the various uses open to it. In England 
the market for new securities is made up of the vague, ill-organized 
group containing the Issue Houses, the company promoters and 
brokers, the underwriters and the advertisement houses ; while 
the market for old securities consists of the highly organized London 
and Provincial Stock Exchanges, in which the active principle 
is found in the jobbers and brokers. The function of the first part 
of the market is to formulate the demand for capital, to present 
this to the public by the offer of securities and to facilitate the 
flow of capital from the public in response. In carrying out this 
function it has to bear the risks arising from the fact that the 
public may fail to supply the capital required, and it has to under- 
take much marketing work in bringing the demand prominently 
to the public notice. Hence it reheves the two groups which it 
brings into business contact of work of management which may 
often involve heavy risks and much labour, and so must often be 
paid a heavy price for its services. The function of the second 
part of the market, the Stock Exchanges, is secondary to the main 
work of obtaining supplies of new capital from the public. It 
contributes to that end by providing facilities by which securities, 
after they have been purchased, may be quickly and cheaply ex- 
changed among the parties who hold them ; for these facilities 
give the investor who subscribes to a new issue an assurance that 
he will be able, whenever he chooses, to recover his capital, or at 
any rate the market value of his security, not indeed from the party 
to whom it has been supphed, but from some other party with 
resources seeking investment. The first part of the market there- 
fore lowers the (real) costs of conveying into the hands of States, 
railway companies and so on, a continuous stream of capital which 


forms a vast stock outstanding in the hands of these various 
parties ; while the second part of the market lowers the (real) costs 
of Waiting and Risk-bearing associated with this outstanding 
stock by providing faciUties for the continuous shifting of these 
costs from one investor to another in accordance with their in- 
dividual circumstances, thereby enabUng this Waiting and Risk- 
bearing to be undertaken from day to day by those who are most 
able and willing to do so. These economies are evidently funda- 
mentally similar to those effected by the banks where the two parts 
are joined together in one organization ; for the banks supply and 
maintain outstanding in the hands of business men a stock of 
capital obtained from their depositors, each one of whom can 
recover his capital at will in accordance with his particular business 

But although the nature of the economies effected by these 
two types of organization is identical, there is, as already noticed, 
a fundamental difference of method which has important social 
consequences. The market for new securities takes over from the 
investor only a part of the work of management ; it leaves to him 
the selection of his investment and consequently the greater part 
of the risks of supply. The Issue houses and company promoters 
offer him securities ; the investment broker will advise him in 
choosing between them ; the financial press provides him with a 
vast amount of information on which he may form a judgment of 
their value ; but this assistance falls far short of that given by the 
banks, who assume the entire responsibiUty for lending out the 
capital deposited with them. When account is taken of the in- 
evitable lack of first-hand knowledge on the part of the pubUc of 
the great variety of securities offered to them, of their credulity 
and their frequently speculative tendencies, it naturally foUows 
that, as already noticed, they annually supply large amounts 
of capital which is absorbed by intermediaries or dissipated in 
profitless undertakings. 

This preUminary review of the work of the market in the trans- 
port of capital from those who supply it to those who employ it, 
shows that, in spite of defects in parts of the organization, it has a 
very powerful effect on the costs of supply. By taking over from 
the capitalist, partly or wholly, the work of management of his 
capital, and by employing expert knowledge and an elaborate 
organization in facilitating its movement to the points of highest 
yield, it reduces greatly the amount of risk and of marketing work 
involved in supply ; moreover, as the costs of Waiting are insepar- 
ably bound up with those of risk-bearing and marketing, their 
reduction directly by the market has an important indirect in- 
fluence in increasing the supply of Waiting, so reducing still further 


the supply price of capital. The work done by the market in 
developing the effective demand for capital necessarily tends, in its 
immediate effects, to raise the price at which the use of capital 
is sold ; but in the long run this tendency is set off, in part or whole, 
by its influence in increasing the productivity of social resources, 
the source from which the annual supply of new saving is derived. 




BANKING forms the centre of the credit system in all de- 
veloped countries. In England it occupies a position of 
the greatest social importance, not only as the first among 
the agencies supplying capital to business men, but also as 
the principal source of the supply of currency and consequently 
the centre from which that supply is controlled The scope of the 
work undertaken by the banking system shows considerable differ- 
ences as between one country and another, differences which are 
natural enough in view of the fact that the form which the system 
assumes is dependent in a peculiar degree upon the character of 
the social organization within which it operates. 

To trace with certainty the causes determining the particular 
form assumed by the English system would involve a resum^ of all 
the complex social conditions in which it developed. But some 
indications of these causes may be found by proceeding in the op- 
posite direction ; by analysis rather than synthesis. If it is possible 
to distinguish the essential conditions on which are dependent the 
English and, let us say, the German systems, a reference to the 
historical facts affecting these main conditions should explain the 
main variations in the systems themselves. There seem to be 
'three main conditions of which account must be taken : first, there 
is the wealth of the people, which determines the amount available 
for the banks to borrow ; secondly, there is the general level of 
public confidence, which mainly determines the amount which 
the banks can borrow ; and, finally, there is the character of the 
demand arising from trade and industry, which largely determines 
the nature of the services undertaken by the banks on the side of 

During the third quarter of the nineteenth century when the 
Credit banks of Grermany were developing, that coimtry was 


definitely poor ; 88 at the same time, the general level of public 
confidence was comparatively low, a condition which, on the one 
hand, limited the power of the banks to borrow, and, on the other, 
encouraged the employment of a centralized note issue rather 
than the use of a cheque currency involving the lodgment of spare 
funds with individual banks. These conditions were in themselves 
sufficient to make simple deposit banking unprofitable, and they 
were reinforced by the character of the demand for capital arising 
from business men. For during this period German industry was 
passing very rapidly to a modern system based on large scale 
production, and there was consequently a heavy demand for the 
supply of capital for long periods for the creation and extension 
of industrial plant. 

The special needs of the peasantry and small work-people were 
met by the creation of an elaborate system of People's banks, 
while the State, by facilitating the establishment of Mortgage 
banks, helped to provide the means by which the spare capital 
of the public was collected and made available for the development 
of agricultural and urban estates ; special machinery was necessary 
to perform a similar office for industry. In these circumstances 
it was only natural that the main part of the German system should 
assume the form of " mixed banks " which undertook not only 
deposit banking but also the conversion and flotation of industrial 
undertakings ; they are indeed " maids of all work." Their 
deposits are relatively small and their paid-up capitals are large ; 
for their operations are more risky than those of the English banks, 
not only in their work of financing industry, but also in their com- 
mercial banking and in tlieir large stock exchange transactions. 
Like the banks of this country, they are in process of rapid con- 
centration and are extending their acceptance business ; in pre-war 
days they made great and successful progress in developing foreign 
trade, not only by their organization for financing overseas commerce, 
but by acquiring control over the industries of other countries ; 
finally, they are endeavouring to complete their organization by 
extending their cheque-making facilities and encouraging the more 
general use of this form of currency among the public. 

In England the system of Joint-Stock banks was assuming its 
form during the second quarter of the nineteenth century. The 
country was growing rapidly rich ; political and social institutions 
were stable and the level of confidence was high ; moreover the 
happy accident of the Bank Act of 1844 encouraged the develop- 
ment of the cheque currency and consequently the lodgment of 
spare funds with the banks. While all these conditions were favour- 
able to the growth of deposit banks, it would seem that the industrial 
need for capital was not of such a nature as to call for special 


machinery for its satisfaction. In England the transition of 
industry to its modem form was more gradual than in Germany ; 
and after 1862 the demand for long-period capital to which it gave 
rise was satisfied in part by the legal facilities granted to joint- 
stock companies. But it seems reasonable to suppose that during 
the whole period the greater part of the demand was met from the 
rapidly accumulating wealth of manufacturers themselves and of 
the parties with whom they were in close business contact.** No 
doubt many other influences played their part in determining the 
form of the English banks ; but those seem to explain in a great 
measure the character of the main body of the EngUsh system as 
a group of banks of deposit and issue, simple in function and 
homogeneous in type. 

Any complete account of English banking must deal with the 
work of the small group of merchant bankers and of the London 
of&ces of the very numerous foreign and colonial banks. But the 
acceptance, foreign exchange, and issue work of these bodies does 
not bear very closely on the present discussion ; accordingly, the 
argument of the following chapters is confined wholly to the work 
of the system of " cheque-paying " banks and their central in- 
stitution, the Bank of England. 

For many years there has been a strong movement of concentra- 
tion among these banks which has resulted in the absorption of 
large numbers of small bankers and the growth of very powerful 
joint -stock institutions, several of w^hom have more than 500 
branches, and lodgments which overshadow those of the Bank of 
England. This movement, due largely to the advantage of com- 
pounding risks and to the needs of large scale industry, has reduced 
the number of banks to about eight private firms and some forty- 
four joint-stock companies, and has left the EngUsh system (in 1914) 
a small group of speciaUzed and highly centrahzed institutions with 
most of its power lodged in the hands of ten or a dozen of its most 
powerful members. 4<* This system is in marked contrast with Con- 
tinental banking. It is far more homogeneous and simple in its 
functions, each bank doing the same kind of work as its neighbour ; 
there is no organization specially adapted to the needs of a par- 
ticular industry, such as the agricultural mortgage banksof Germany ; 
and there is nothing, except perhaps the Trust and Finance com- 
panies, which corresponds to the French and German Mortgage 
banks who raise capital by the issue of their own bonds and lend 
it for long periods to municipalities or against mortgages of real 
property. The system is more unified, more concentrated, than 
that of Germany, France or America ; for example, in Germany, 
there were still in existence, in 1907, more than 4000 private 
bankers ; in France some 2700.*! Finally, owing partly to the great 


size of most of the English banks, partly large issues of 

cheque i^arrencyj Iheir dependence jon the.fientral institutiQn is. rnuch,, 
less than in France and Jle^^ the. power of the State 

J)anks jis_greatlj7 jncreased by .tljeir large issues QLbankrnoles. 

TJhe following table gives a statement roughly representative 
of the position of the English banking system as a whole at the end 
of 1913. Some of the figures are conjectural ; most of them are 
for various reasons a little inaccurate ; but they serve to give a 
general impression of the scope and character of the operations of 
the system, which is all that is required for the purpose of the 
argument which follows. 

Estimates of the Aggregate Liabilities and Assets of the Bank of 
England and the Joint-Stock and Private Banks of England and 
Wales, roughly corrected for duplication, etc., as at the end 
of 1913 *2 

l^- £ m. 

('apital, Reserves and Undivided Gold, Silver and Bronze, say 100 

Profits . . . . . . . . 109 Cash at Call and Short Notice, 

Lodgments — approxmately . . . . 104 

On Current A /c, say £s^o Investments .. .. .. 138 

On Deposit A /c, say 280 Discounts (about one-quarter) 

840 and Loans . . . . . . 609 

Notes . . . . . . . . 9 Miscellaneous : Uncleared 

Miscellaneous Items . . . . 6 Cheques, say . . £^ 

Buildings . . . . 5 

— 13 

;^964 m. ;^964 m. 

The work done by the English banking system includes a variety 
of minor services such as the purchase and„sale_Qf securities throug;h_ 
thebanks' brokers^^^the safe custody of. -valuables^thacallectioii._oL 
coupQri§...aiid_.biUs_of exchange, the issue_..o.f drafts and. letters M « 
credit and ..§£L. .OIL It includes also Savings bank arrang^ents 
and an increasing amount of acceptance and ff^rdgn exchange^ work^ 
But these functions are relatively of quite minor importance and 
do not appreciably modify the simple character of the English 
system. Essentially the system is composed of banks of deposit 
and issue. Its social contribution consists, therefore, of two services f 
the first is the transpo rt of_capitalj^ the second is the provision of 
a curre ncy. These two services, though intimately connected in 
practice, are quite distinct in theory. 

The first service consists in carrying capital (or, more accurately, 
command over capital) from those who have it to those who use it^ 
This work is essentially independent of the nature of the currency, 
and may be carried out with a circulating medium of paper, gold 
or any other of the many different materials which from time to 


time have served the purpose of money. Let us suppose that this 
work of transport comes first in order of development and assume, 
for the moment, that the currency consists wholly of gold. In these 
circumstances the pubhc will retain in pockets and cash-boxes the 
quantity of gold which they need to carry through their monetary 
transactions, and will lodge with the banks the gold which they 
do not require for these purposes but which they nevertheless wish 
to have in the readily available form of a bank deposit. The aggre- 
gate of these lodgments (added to paid-up capital and accumulated 
reserves) will then form the total resources at the disposal of the 
banking system ; that is to say, the stock of gold lodged with the 
banks in this way will govern the amount of their loans just as 
definitely as the wholesaler's supplies to retail shops are governed 
by the stocks which he receives from the manufacturers. Bankers, 
retaining like any other business men a part of their resources to 
meet current demands and possible emergencies, will convey this 
gold into the hands of business men and others who bid for its use, 
an operation which their wide business connexions and expert 
knowledge enable them to do with great economy in trouble and 
risk. In these simple conditions then, the banks' social function 
consists only in retailing capital ; or more precisely, in the distribu- 
tion of capital among those who offer the highest net rate for its 
use — ^those presumably who employ it in the uses in which its 
yield is highest. 

We may now suppose the banks to superimpose on this simple 
work of transport their second service of supplying a paper currency. 
This second service is evidently entirely different in nature ; it 
consists in the partial substitution for this medium, gold, of their 
own circulating medium, the cheque, or deposit, currency. In 
effect the banks offer to supply the pubhc with cheque-making 
facihties in exchange for the use of the gold which is still held in 
pockets and cash-boxes. Accordingly the greater part of the 
remaining stock of gold is lodged with the banks as a basis for 
cheque-making ; the public obtaining at no greater cost to them- 
selves a more convenient means of carrying out their transactions ; 
the banks undertaking additional work and recovering payment 
for it from the use of the increased quantity of resources placed at 
their disposal. 

It must be noticed that this substitution of paper for gold is 
not a thing sui generis. Money forms part of the system of transport 
and must be included \vith railways and ships as the means by 
which goods are transferred from one person to another. The 
substitution of paper for gold is therefore quite similar in its effects 
to the replacement of wood by steel in trading ships ; in each case 
it results in a reduction in the cost of conveyance of goods. As 


already noticed, this substitution increases the resources at the 
disposal of the banks ; it increases, therefore, the importance of 
their work as transporters of capital ; but it does more than this, 
for it enable s t hem to shift thes^espurces from point to poi nt in 
accordance mth the neeHTof borrowers far more cheaply and 
rapidly than would be possible with a currency composed of gold 
or some similar material. 

This preliminary consideration of the work of the English 
banks leads to the following simple and concrete view of their 
operations. The public make over to the banks the use of two 
parts of their total wealth. The first, consisting of a share of that 
fraction of their resources which they invest in -d readily available 
form, gives rise to lodgments on deposit account yielding a rate 
of interest. The second, consisting of the greater part of that 
fraction of their resources which they" hold in the form of money, 
gives rise to lodgments on current account yielding the services 
of the cheque currency. Together, these lodgments convey to the 
banks a control over a specific fraction of the country's resources ; 
when added to capital and reserve funds they constitute the total 
resources at the disposal of the banking system, and consequently 
govern absolutely the quantity of command over capital which 
can be carried into the hands of borrowers, that is to say, the volume 
of the banks' loans. According to this provisional view, then, the 
banks obtain resources partly in exchange for a rate of interest, 
partly in exchange for cheque-making facilities ; they combine 
these with their capital and reserve funds and distribute the total 
among the various employments open to them. So far, then, 
banking appears as a comparatively simple matter and gives rise 
to three main questions. First, the economy effected by the 
system in making available for productive employment the small 
and individually useless items of capital of which lodgments are 
composed — ^an economy measured inversely by the size of the 
banks' reserves ; second, the efficiency with which they distribute 
these resources among their various uses and the loan poHcy govern- 
ing that distribution ; finally, the greater convenience of the cheque 
currency which they supply. These questions are dealt with in the 
first three of the following chapters. 

There can be little doubt that the view which has just been 
stated represents the fundamental facts of the situation — the main 
influences permanently underlying and determining the banks' 
operations. The view is complete enough as regards lodgments on 
deposit account, but it makes an assumption with regard to lodg- 
ments on current account which tacitly excludes the most difficult 
questions which the banks are called upon to face. It assumes 
that, whatever may be the volume of money work, the pubUc are 


able to hold in the form of cheque currency just that fraction of 
their resources which from time to time is necessary to carry through 
that work. In point of fact, however, the power to vary the volume 
of the cheque currency in accordance with the volume of work to 
be done rests only to a small extent with the public. It rests 
mainly with the banks. And this fact introduces a new set of 
considerations and a point of view very different from that which 
has just been stated. 

In dealing with the substitution of the cheque currency for 
gold it has been supposed that the pubUc brought their gold to the 
banks, lodged it on current account and obtained in exchange 
cheque-making facilities. The public still can, and do, obtain 
supphes of cheque currency in this way ; but it is evident that, 
when once the substitution is fairly complete, the increasing supplies 
required to carry through the growing volume of money work 
must be obtained in another manner. They must be issued by the 
banks as notes are issued — ^namely, by way of loan. Accordingly 
the typical method of issue becomes one by which the banks grant 
cheque-making facilities to borrowers, the cheques drawn by these 
borrowers reappearing as an increase in the lodgments of other 
parties, and the total volume of lodgments on current accomit, i.e. 
the volume of cheque currency outstanding, showing a corre- 
sponding increase. In actual practice, therefore, loans precede 
lodgments and, in a sense, create them. The banks are free, so 
far as legal restrictions are concerned, to lend as much as they 
choose ; each expansion in their loans is followed by an increase 
in lodgments, and there appears to be nothing in the actual 
mechanism of the operation which need prevent this process from 
being continued indefinitely. It is clear that when the banks 
arbitrarily expand their loans in this way they are transferring 
to borrowers a command over capital which they compulsorily 
abstract from the community ; for their action increases the volume 
of lodgments and so lowers the purchasing power of each unit of 
currency in the hands of the public. Its effects are seen in rising 
prices and other signs, showing that the purchasing power of the 
country is in excess of its needs. 

These considerations give rise to a new set of questions. They 
require us to consider, in the first place, whether the supply of 
currency, Uke that of other commodities, can be left to the ordinary 
play of market influences, or whether the pecuHarities of a currency 
and the consequences of a maladjustment in its supply are so 
important as to call for special measures of regulation. Given 
the need for unified and deUberate regulation it becomes necessary 
to ascertain whether the supply of this currency is sufficiently 
elastic and the points in the system at which the power to control 


this supply is lodged. Finally, we have to discuss the manner 
in which supplies are in fact controlled, and whether any modifica- 
tion in the loan policy of the banks would lead to a closer adjust- 
ment between the volume of their cheque currency and the volume 
of the money work which that currency has to carry through. 
These questions are taken up in that order in later chapters on 
this subject. 

We have, then, these two points of view. The one, taking 
account of ultimate social facts, represents the loans of the banks 
as governed by their lodgments, and these lodgments as governed 
in their turn by the fact that they are portions of the pubhc 
wealth set aside for more or less specific purposes. The alterna- 
tive view takes account of the practical difficulties of adapting 
the supply of cheque currency to the public needs. It recognizes 
that the banks issue their currency by means of loans which 
reappear as lodgments, and consequently that the volume of 
lodgments is governed by the volume of loans, which in its turn 
is governed by the will of the banks. 

The apparent antagonism between these two points of view 
seems to be the source of most of the difficulties in reaching con- 
clusions as to the true meaning of banking operations. From 
one point of view lodgments consist of real wealth and govern 
loans ; from the other, loans consist of paper and govern lodg- 
ments. It is clear, however, that the two views are not antagon- 
istic but complementary to one another ; the former describes 
the adjustment which social interests require ; the latter de- 
scribes the means by which this adjustment is, or may be, effected. 
The banks may vary the amount of their loans and consequently 
the amount of their lodgments as they please ; but their own 
safety and the welfare of society depends on their maintaining 
the volume of lodgments on current account at a level just 
sufficient to enable the public to carry through the volume of 
their money work without disturbing the general level of prices ; 
the volume of cheque currency being rightly adjusted, lodgments 
on deposit account are also in equilibrium. If the banks lend 
more than this they are in effect making a forced levy by reducing 
the value of each unit of money in the hands of the pubUc ; they 
are merely diluting the cheque currency which they have cdready 
issued and disturbing the economic organization by supplying 
purchasing power in excess of the country's needs. If they lend 
less than this, they fail in their task of supplying people with the 
means for carrjdng through their money work. If, however, 
they lend just this amount and no more, the system is in equiUbrium ; 
the banks are carrying into the hands of borrowers a command 
over capital which the public have made over to them ; their 


lodgments and their loans represent wealth as truly as though 
they had been made in gold coin. 

In the following chapters the argument will deal in more 
detail, and in the same order, with the various questions touched 
on in this preUminary statement. In the earlier chapters it will 
be assumed that the banking system is in the equihbrium which 
has just been described. Throughout, the discussion will deal 
primarily with conditions in which an effective gold standard is in 
operation ; that is to say, with a condition which existed in pre- 
war da}^ and with a condition which may reasonably be expected 
to be re-established in a few years' time. The rapidly changing 
circumstances of the intermediate period give rise to special problems 
which need more detailed and realistic treatment than is possible 
in these pages. 




THE English Deposit Banks in their work as transporters 
of capital effect two economies. By collecting and 
pooling small items of capital individually unimportant 
they make a large stock of capital permanently available 
for business and other uses. As expert lenders they supply this 
capital to borrowers at low gross rates. These economies need 
separate consideration. 

In 1914 the aggregate lodgments of these English banks 
amounted to some £840 m. This aggregate, collected at about 
5000 branches, was composed of many hundred thousands of 
individual lodgments, each one of which, broadly speaking, was 
repayable in gold on demand. The typical lodgment consists, 
therefore, of a quantity of resources comparatively small in amount 
and supplied for a short, or at any rate, a very uncertain period 
of time. Regarded as a supply of capital the individual lodgment 
taken by itself is practically valueless for business purposes ; 
either its insignificant amount would make the cost of marketing 
it disproportionately high or its Uabihty to be recalled at any 
moment would make it useless for employment for ordinary 
business purposes. When, however, these hundreds of thousands 
of individual lodgments are compounded in one organization two 
results automatically follow : the small quantities of capital are 
formed into one large aggregate ; and, the ebb and flow of one 
account being set off by the flow and ebb of another, the short 
lengths of capital are also added together ; the net result being 
that a proportion of the capital lodged becomes available for 
continuous employment in trade and industry. The measure, 
therefore, of the first economy produced by the banking system 
is the effect of this pooling operation in releasing capital for profit- 
able employment. 

The proportion of their lodgments which the banks are able 
to employ effectively, or, inversely, the proportionate size of their 
reserves, is determined immediately by experience of what is at 
the same time economical and safe. This experience sums up 



the effects of many more remote influences lying partly in the 
circumstances in which the banking system operates, partly in 
the nature of the system itself. 

The proportion of reserves to lodgments will naturally vary 
as between one country and another. It will depend on the 
stability of political and social institutions and on the wealth 
and character of the people, for these conditions will largely 
determine the possibilities of sudden demands for the withdrawal 
of lodgments. It wiU depend also on the extent to which the 
system is exposed to demands for gold or other legal tender 
originating in the exigencies of foreign countries, or in home 
fluctuations arising from such causes as seasonal variations in the 
volume of payments to be effected by means of coin and notes : 
the former source of disturbance is particularly important in 
England owing to her international position in finance ; the latter 
is especially marked in France during the harvest period and 
in Germany at the turn of the quarter. It will depend, further, 
on the character of the deposits which the public lodge with the 
banks ; for a balance of £100,000 held by a foreign Grovemment 
at the head office of a London bank evidently calls for a far 
higher reserve than £100,000 composed of a thousand independent 
balances whose movements largely cancel one another. 

In addition to these external influences affecting the size of 
the banks' reserves are those arising from the nature of the system 
itself. The efficiency of the system in this part of its work depends 
mainly upon the absolute number of lodgments it collects and 
the degree of independence in their movements ; for if this in- 
dependence disappears in the face of financial mistrust leading 
to a general withdrawal of lodgments, the whole basis of the 
operation vanishes. Its _ efficiency will be mainly determined, 
therefore, -firsts ±ty. the reputation of thfi JJ2djvi_4aal banks_c_Qm-_ 
posing the sy stem (a reputation dependin g partl y on the s ize of ^ 
their , paid-up capital ^nd_accumulated reserve fiinds) ; _ for the 
greater thejpublic confidence, the larger is likely to be the number^ 
oi lodgments andthesmalb the risk of a general withdrawal by 
the publlcu. It will be influenced, secondly, by the_ development of^ 
the uni fied systems of b ranch o ffices which is typical^ of English.^ 
banking, or by the CQTPnmnitip*^ nf infprpc;t mnrp rnmmon i^ 
Germany ; for the larger the number of offices controlled by a 
single bank, the more fully will the fluctuations of individual 
lodgments be pooled. Finally, when a central institution holds 
the cash balances of the individual banks and pools the fluctua- 
tions of these balances, the maximum economy of reserves is 
obtained and the largest possible fraction of the aggregate lodg- 
ments becomes available for productive employment. These 


considerations formed, no doubt, only a part of the reasons which 
led the U.S.A. to adopt a centralized system of banking ; but 
it is clear that, apart from legal regulation, the aggregate reserves 
held by their 30,000 small, independent banks must of necessity 
have been proportionately far larger than will now be required, 
and consequently that the recent reform is likely to effect a very 
appreciable economy. 

It is worth noticing at this point that estimates of the relative 
strength of any two banking systems based on a comparison between 
their proportionate reserves are difficult to make, not merely be- 
cause of the differences in the organization of the systems and of the 
conditions in which they operate, but also because the comparison 
may be obscured by differences in methods of bookkeeping. When, 
for example, a bank agrees to lend a business man £1000, it may do 
so in either of two ways. It may, in the one case, open a loan 
account for £1000 in his name and simultaneously credit him on 
current account with a similar amount ; or it may, in the other case, 
grant him a " hne of overdraft " of £1000, allowing him to overdraw 
to that extent as and when he chooses. In the former case lodg- 
ments are immediately increased by £1000 ; in the latter, they 
may be gradually increased to about this amount. If the same 
absolute amount of reserve is held against the new liabiUty in each 
case, the proportionate amount of reserve will appear lower under the 
former method when lodgments are immediately increased by £1000, 
than under the latter when they are gradually increased as the power 
to overdraw is exercised. 

The English banks make their advances partly by way of loan, 
partly by way of overdraft. A simple statement of the ratio between 
their reserves and their lodgments, therefore, will give an accurate 
idea of their ability to meet contingencies only if it is supplemented 
by information as to the extent to which they have lent in one 
way or the other. Further, any comparison of the strength of their 
position, which is based on a change in this ratio as between one 
time and another, may have been made inaccurate by a change 
from one method of lending to the other during the interval. 

In England the external circumstances in which the banking 
system operates are especially favourable ; at the same time, the 
reputation of the banks of which it is composed is very high and their 
organization very economical. They are able, therefore, to pool the 
fluctuations of their lodgments more effectively than any other 
system which has yet been devised. 

The proportion of these total lodgments which the banks as a 
whole are, in fact, able to release for productive uses is not shown 
exactly by the total of their loans, for the resources at their disposal 
for lending purposes include not only their aggregate lodgments 


but also their paid-up capital and accumulated reserve funds. This 
proportion (in 1914) is most conveniently found therefore by con- 
sidering the size of that fraction of their lodgments which they are 
unable to lend, that is to say, the stock of gold and silver which they 
must retain in order to meet demands for repayment of lodgments 
in cash. 

A net withdrawal of lodgments may occur daily for the purpose 
of effecting minor cash transactions, weekly for the payment of 
wages, seasonally for holiday and other expenditure, cyclically to 
meet the larger cash needs of more active business and conceivably 
in consequence of a widespread lack of confidence in the banks. A 
cash balance is held by each branch of a bank to meet immediate 1 
contingencies ; minor fluctuations in the balances of individual 
branches are pooled by the head o£&ce ; fluctuations in the balances 
of individual banks are pooled by the Bank of England. To this/ 
must be added the gold and silver held by the Bank of England, 
partly for the purposes already described, partly in order to meet 
foreign demands. The grand total amounting to some £100 m. 
represents that fraction of its total lodgments which the banking 
system is unable to lend out at interest. The whole of the remainder, 
say, £740 m., is released for employment in productive uses. This ^ 
aggregate, seven-eighths of the total lodgments, may then be re- ' 
garded as a stock permanently lodged with the banking system, i 
though continuously shifted from one account to another in response j 
to cheque payments made by depositors. 

This shifting of lodgments within the banking system does not 
appreciably affect the total resoxirces controlled by the system as a 
whole ; but it is a matter of the greatest importance to the indi- 
vidual banks of which the system is composed, and forms one of the 
reasons which require them to keep further reserves much larger in 
amount, though different in kind from those which have just been 
discussed. The movement of lodgments from one bank to another 
is adjusted daily by means of the Clearing House, each bank pre- 
senting cheques on other banks paid in by its customers and receiv- 
ing from these other banks cheques on itself ; the balance being 
paid or received by a draft on the Bank of England. Normally 
the net balance which any one of the Joint-Stock banks pays or 
receives to complete the daily settlement may be small and the 
amount of its lodgment with the Bank of England consequently 
little affected ; but the occasional fluctuations in this balance may 
be very large. If, for example, Lloyds Bank were receiving sub- 
scriptions for a foreign loan of £20 m., lodgments to the extent of 
perhaps £15 m. might be shifted from banks in general to Lloyds in 
particular. Other banks would need to deplete their lodgments at 
the Bank of England by £15 m., and Lloyds' balance at the central 


bank would be increased by a similar amount. But there is no 
need to enter into any further detail on this point. The important 
fact is that, owing to the movement of lodgments within the bank- 
ing system, individual banks are obUged not only to keep consider- 
able balances at the Bank of England, but also to increase the pro- 
portion of their resources which they hold in a readily available form. 
The aggregate amount which the banking system held (in 1914) 
** at call and short notice " was about £104 m., or one-eighth of 
the aggregate lodgments ; this amount, together with the funds 
similarly held by the Foreign and Colonial banks, was the main 
source of supply of the short loan market. It must be noticed that 
the necessity for tliis reserve arises largely from the fact that the 
system is composed of individual banks ; as the number of separate 
banks declines, the movement of lodgments is pooled by each to an 
increasing extent, and the need to hold a reserve against this move- 
ment declines in a corresponding degree ; if, finally, the system were 
composed of a single bank, the movement of lodgments would be com- 
pletely pooled and the need to hold a reserve of " cash at call and 
short notice," at any rate for this particular purpose, would dis- 
appear. This reserve of " short money " differs from the reserve of 
gold inasmuch as it is lent to the business community and con- 
sequently employed in productive uses ; but as it is lent only for 
short periods it requires borrowers to bear the risks arising from the 
fact that it can be recalled at short notice ; these risks, therefore, 
constitute the social cost of maintaining this reserve. 

In estimating finally the net economy effected by the banks' 
pooling operation, we have to take account of two things. First, 
some allowance must be made for the fact that although individual 
lodgments consist mainly of small quantities and short lengths of 
capital they would not be wholly unavailable for business use in the 
absence of the banks ; for some part of the lodgments, at any rate 
on deposit account, could in such circumstances be invested by 
their owners in negotiable securities or in other ways. Lodgments 
on deposit account form, however, only a minor part of the banks' 
total lodgments, and the allowance to be made under this head is 
probably not a large one ; it seems safe to assume that the pro- 
portion of the total lodgments to which the pooling operation can 
be considered to apply is not less than five-sixths, say, £700 m. 

The second consideration is the fraction of this £700 m. which 
the banks are, in fact, able to release for productive employment. 
Owing primarily to the public confidence in the banks and second- 
arily to the centralization of the reserve, the fraction of these 
lodgments which cannot be lent, i.e. the quantity of gold and 
silver held to meet lodgments actually withdrawn from the banking 
system, is extremely small and amounts perhaps to £100 m. So 


far, therefore, the pooling operation may be said to liberate £600 m. 
of resources for profitable use. But owing partly to the circum- 
stance that the system is composed of individual banks and partly 
to the need to provide against uncertain contingencies, some £104 m. 
of these resources are lent only for short periods, and consequently 
result in special risks falling upon those who employ them. We 
conclude finally, then, that the high business reputation and 
economical organization of the system enable the banks to effect 
an economy whose amount is measured by the profitable use, 
subject in part to certain risks, of some £600 m. of resources other- 
wise unavailable for productive employment. At 3 J per cent, the 
net rate of interest in 1913, this represents an annual gain of some 
£20 m. 

This economy represents, of course, not a net but a gross saving. 
It is derived from the effective use of lodgments obtained on both 
deposit and current account. The profit from the use of the former 
kind of lodgment is paid over to depositors in the form of a rate of 
interest which represents in the main a net social gain. That from 
the latter kind is paid over in the form of cheque-making facilities 
whose costs of supply must be deducted from the gross economy 
effected. It may not be assumed that the cost of the cheque 
currency is necessarily less than that of the gold it replaces. 
The substitution of the cheque currency for gold means the transfer 
of the costs of production of the currency from the Mint to the 
banks ; and although the analogy of a note issue may suggest that 
the banks must obtain a surplus on their issues, the view seems 
to be fallacious. This point will be dealt with in a later chapter ; 
for the moment, therefore, the statement may be allowed to stand 
that the cheque currency has a cost of production like any other 
commodity, and that the economy resulting from its substitution 
for gold is to be measured primarily by its superior efficiency in 
effecting exchanges. The remaining economy resulting from the 
operations of the banks as transporters of capital lies in their work 
as expert lenders ; this is considered in the following chapter. 


IN this chapter we are concerned with the manner in which 
the banks normally distribute the resources at their dis- 
posal. We deal with their loan poUcy, therefore, only in 
a preliminary way, taking account of those considerations 
which constitute " practical banking," and postponing to a later 
chapter the consideration of those influences which determine 
fluctuations in the aggregate volume of loans and lodgments. In 
other words, we deal with that part of their loan policy which 
is concerned with the distribution of a given quantity of Command 
over Capital, and leave for later consideration that more difficult 
part of their loan policy which is concerned with the regulation 
of the total amount of Command over Capital which they supply. 
For this purpose we may employ the figures of the 1913 balance 
sheet given on page 128. 

The resources controlled by the banks consist of lodgments and 
notes to the amount of about £850 m. and capital and reserve funds 
amoimting to £109 m., giving a grand total of some £960 m. Their 
distribution is naturally governed by two main considerations. 
On the one hand are the ordinary business interests which require 
that the largest possible fraction of these resources should be 
devoted to profitable employment. On the other hand is the ordinary 
business need to make provision for contingencies. 

The manner in which those resources are employed must neces- 
sarily be governed very largely by the conditions on which they are 
obtained. The fact, therefore, that nearly 90 per cent of their 
total resources are repayable practically on demand must be one 
of the dominating considerations in the minds of bankers when 
distributing the resources at their disposal. Long experience, it is 
true, has clearly exposed the extent of the normal ebb and flow of 
resources from and to the system in the course of the yearly cycle, 
and has no doubt made it more easy to estimate the amount of the 
payments which individual banks have to meet as a result of the 
shifting of lodgments from one bank to another within the system. 
But every year brings its own emergencies, and the banks cannot, 

simply by basing their pohcy on past experience, shake themselves 



free of the fact that a large proportion of their lodgments are repay- 
able on demand ; they must provide a large margin for the uncertain 
contingencies of the future. 

These conflicting considerations of what is profitable and what is 
safe express themselves in a loan policy which aims at maintaining 
a certain definite proportion between UabiUties and reserves. The 
main principle governing the loan pohcy of the Joint-Stock banks, 
and presumably of the private bankers also, is therefore that their 
Cash in Hand and at Bankers, their Investments, and their Money 
at Call and Short Notice should each, subject to a limited degree of 
interchangeabiHty between the three, constitute a certain definite 
fraction of their lodgments. Of these proportions the most im- 
portant is that relating lodgments and " cash." This fraction is 
no doubt lowest where the need is greatest, namely, among the 
small private banks whose fate may be bound up with the prosperity 
of a single industry or at any rate of a small geographical area. 
The proportion actually adopted by the Joint-Stock banks naturally 
differs with the special conditions of each ; for it must depend upon 
the judgment of its directors, on the extent to which the bank can 
pool the fluctuating demands of the various industries and trades 
with which it deals, on the character of its loans and lodgments 
and so on. The monthly statements of eleven large Joint-Stock 
banks show that their aggregate, or average, proportion is a fairly 
stable one ; for example, during the year ending April 1914 (prob- 
ably rather an exceptional period) the fraction of their total Cash 
in Hand and at Bank of England to their total lodgments varied 
only about i per cent from the average, the extreme figures being 
14-9 per cent and i&S per cent. The proportion on which the loan 
poHcy of the Bank of England largely depends — that between the 
reserve in the banking department and its total lodgments — ^natur- 
ally varies within much wider limits, for upon the central bank of 
the system faU practically the whole of the yearly fluctuations 
in the demand for cash and cheque currency ; during 1913 this 
proportion varied from 30 per cent to 61 per cent. 

It should be noticed that the proportionate figures which have 
been quoted are misleading in so far as they show the relation of 
reserves to lodgments at a moment of time. Banking poUcy does 
not, of course, aim at maintaining a rigid and invariable proportion, 
whatever the circumstances at the moment ; it is based rather on 
an average of existing conditions and those foreseen in the im- 
mediate future. A Bank of England proportion of 30 per cent, 
with the prospect of an early inflow of gold or repayment of loans, 
may indicate a stronger position than a proportion of 61 per cent 
with a less favourable outlook. With these important relations 
between lodgments and reserves we shall be more concerned in 


later chapters dealing with the regulation of the total volume of 
loans ; at the moment we need chiefly to distinguish the nature of 
the various uses in which the banks' resources are employed. 

Little need be said on the subject of the £138 m. held in the 
form of Investments. But it may be noticed that these holdings 
are not investments in quite the usual meaning of the term ; they 
are selected not so much on the ground of their net yield as of their 
wide and immediate marketabihty ; their primary character, there- 
fore, is that of a reserve. 

A further and more important reserve consists of " Money 
at call and short notice," amounting approximately to £104 m. 
A very large proportion of this is recallable within a week, the whole 
perhaps is recallable within a month ; that is so, at any rate, in 
the case of one of the large banks. Some part of this money is lent 
to the Stock Exchange for fortnightly periods at fairly high rates 
which are fixed by mutual agreement among the bankers. The 
result of confidential inquiry into the volume of loans outstanding 
with the London Stock Exchange at the outbreak of war showed, 
it is believed, a total of about £80 m.*3 As this amount was prob- 
ably less than was commonly anticipated it cannot be considered 
as abnormal. Some of it, no doubt, was borrowed from Discount 
Houses and similar sources, but the great bulk of it must have been 
supplied by the Joint-Stock Foreign and Colonial banks. But much 
the greater part of the short money supplied by the banks with 
which we are here concerned appears to go to bill brokers either by 
the purchase of bills nearing maturity or in the form of loans at 
call or for periods not exceeding a week. 4* These bill brokers 
consist of two or three large Discount Houses and about twenty 
private firms. Primarily they are specialists in bills ; but the 
economy which they effect by virtue of their special knowledge of 
this particular kind of security is not, it would seem, the only 
service they perform. For the effect of their operations is, in some 
measure, to convert " short " into " long " money ; they gather 
up short lengths of capital from a large number of the London 
banks, combine these with their own capital and with that borrowed 
from other sources and lend out this aggregate all over the country 
for periods suited to the needs of commerce. 

In considering, therefore, the real social cost of the reserve 
of short money held by the banks, allowance must be made for the 
work done by the market in making this money available for longer 
periods. The whole of the " short money " which is held by the 
banks in the form of investments is converted into " long money " 
by the organization of the Stock Exchange, while much of the 
remainder is similarly treated by the bill brokers. The real cost 
of this reserve is therefore less than it appeared in the discussion of 


the previous chapter ; it must be taken to consist partly of work 
done by jobbers and brokers on the Stock Exchange and by brokers 
in the bill market, and partly of the additional risks borne by 
business men who borrow from the banks with the Uabihty to repay 
at short notice. 

The manner in which the remaining £600 m. of the banks' 
resources are supphed to trade and industry has been determined 
to an appreciable extent by the policy of the private banks which 
have now to a great extent been absorbed. No doubt, as time 
passes and the long loans made by those private banks are gradu- 
ally recovered, the position of the modern banks will be materially 
improved, their resources being distributed in advances both better 
secured and more readily recoverable. The substitution for the 
small private bank of the large joint -stock concern marks then a 
change in the character of bank loans ; not only is a larger pro- 
portion held in cash and short money, but advances are made for 
shorter periods and against better security. 

This substitution is accompanied by a change to a more cen- 
traUzed form of management and a further modification of loan 
poUcy. The influential and responsible local banker is replaced 
by the more mechanically trained branch manager, less well in- 
formed on local matters and closely controlled by his general 
manager, whose sanction must normally be obtained before the 
grant of an advance of any considerable size. In these circum- 
stances it is inevitable that local knowledge of persons should play 
a smaller part than formerly in the banks' loan poUcy and that this 
poHcy, being determined rather more by the nature of the security 
offered than by the character and abihty of the borrower, should 
tend to exclude from these borrowers business men who may be 
unable to offer security for a supply of capital but whose character 
and abihties give them a good social title to its use. 

The poUcy adopted by the banks in lending this part of their 
resources is necessarily influenced by the possibility that large 
amounts of their lodgments may at any moment be withdrawn or 
transferred elsewhere ; their requirements are most completely 
met, therefore, when they finance a short trade process represented 
by a sound commercial biU, for the bill has a market and could be 
sold if necessary; moreover, it automatically becomes cash at a 
known and not distant date. 

But a more important influence on loan policy must be the 
character of the demand. The possibiUties of the bill, as a means 
by which the demand of the small business man can become 
effective, are Uttle developed in England as compared with France. 
In that country, banks discount bills of five francs and upwards, 
and the total number of bills dealt with is extremely large. The 


number taxed in 1912 exceeded 108 millions, with an aggregate 
value of £1800 m. ; of these more than 60 millions were drawn 
for sums less than 100 frs. In Germany, where the commercial 
bill is much less widely used, the total value of the bills taxed in 
1913 (excluding certain foreign bills) was £1700 m., their average 
value being much higher than in France. In the United Kingdom 
the total value of bills taxed in 1913 (excluding sight bills) was 
approximately the same.**^ 

The guarantee is still of considerable importance as a personal 
security ; but, apart from bills of exchange, the property employed 
in trade and industry does not usually give rise to a security accept- 
able to a banker. The huge increase in the quantity of negotiable 
securities and their wider distribution must, therefore, have a marked 
effect in reducing the risks falling on the banks and widening the 
effective demand for the capital they supply. If they can lend 
most of their resources against good security for fairly short periods, 
it is unreasonable to expect them to revert to the practice of the old 
private banks and to adopt the more risky poHcy which would be 
necessary in order to meet the demand for long-period capital in 
industries which offer less adequate security for loans. 

It is probably true that practically all London loans and the 
great majority of country loans are secured ; the security obtained 
naturally varies widely, but it does not exclude such charges as 
mortgages of land and business premises. Nominally these loans 
are usually for short periods, say six months ; in fact, however, 
they may frequently run for periods of years. There can be no 
doubt, therefore, that, as a result partly of their own, partly of their 
predecessors' policy, a considerable part of the banks' advances is 
supplied for periods extending to several years. 

It is an obvious fact that the parties who lodge their resources 
with the banks have, generally speaking, no knowledge whatever 
of the parties by whom those resources are employed. But the 
fact is worth emphasizing, as it shows how great is the economic 
gap bridged by the banking organization. The essential means 
by which this gap is bridged is the system of local offices, numbering 
in 1914 about 5000 ; this system is supplemented and its efficiency 
increased by the use of the cheque currency. The effective manner 
in which the system serves to collect and compound fragments of 
capital has already been dealt with ; it is no less effective in that 
part of the banks' work which we are now considering — ^the distri- 
bution of this capital at low and even rates throughout the country. 

With a gold currency, lodgments collected in areas of plenty 
would have to be carried to areas of scarcity in the form of metal, 
and geographical distance would exercise a material influence on loan 
rates. In effect lodgments are still transported from one part of the 


country to another, but practically aU costs of carriage are abolished 
by the mechanism of the cheque currency. Thus, the grant of a loan 
by a branch bank must normally coincide with either an increase 
of lodgments or a reduction of loans in some other branch of the 
bank ; loans are simultaneously extinguished at one point and 
extended at another, so that in effect resources are transported by 
entries in the books of the Head Office. Having decided to grant 
a loan, the branch bank need take Httle or no account of its stock of 
gold or notes ; with the sanction of its Head Office, it creates, 
itself, the currency which is required by granting cheque-making 
facilities to its borrower. Moreover, the effect of the cheque currency 
is not only to aboUsh costs of transport, but greatly to increase the 
rapidity with which capital may be placed at the disposal of business 
men, enabling them to undertake operations which a few days' 
delay might render useless or unprofitable. 

The branch bank system and the cheque currency are then the 
two important material sources of the economy with which the 
banks distribute the capital at their disposal. This economy is an 
important one, for it would, perhaps, be a fair illustration to assume 
that capital obtained in Devonshire at 2 per cent, or its equivalent 
in currency services, was carried to Yorkshire and lent there at 
rates not exceeding 4 per cent. But the economy is probably not 
as great as it might be. G)sts of transport have been aboUshed, but 
loan rates are not level throughout the coimtry ; they tend to a 
lower level in the North than in the South, a result almost certainly 
due to differences in the keenness of bargaining. Competition 
among the banks has increased in a marked manner during recent 
years ; but there is every reason to suppose that their profits are still 
higher than is necessary. The old tradition of banking still lingers, 
and many people do not care to make their banking account the 
subject of a bargain. Hence bankers are often able not only to 
maintain loan rates above their competitive level, but what is 
probably more important, are frequently able to obtain lodgments 
on current account yielding a return much greater than the cost of 
the cheque-making faciUties suppHed in exchange. 

Considering the English banks in their capacity as banks of 
deposit or transporters of capital, we have, then, the following 
conclusions. By means of their high reputation and comprehensive 
organization they are able to collect portions of capital most of 
which, apart from their operations, would be economically useless ; 
combining these with their capital and reserves they compound 
them so effectively that a very large proportion is released as a 
practically permanent stock available for productive employment. 
Nevertheless, the fact that the total stock of capital at their disposal 
is in a large measure repayable on demand, requires them to supply 


it mainly, but by no means entirely, for those uses from which it 
can be readily recovered. Their organization enables them to shift 
this capital from one district to another with extreme ease, and 
consequently to redistribute it readily in response to the seasonal 
and other changes in the demands of trade and industry. More- 
over, the rapidity with which they can supply capital at any point 
adapts them peculiarly to meet the temporary opportunities and 
emergencies of business, and consequently enables them, in effect, 
to ensure business men against many of the financial emergencies 
to which they are exposed. 


IN order to complete the account of the normal economies 
effected by the banking system when in equihbrium, some- 
thing must be said of its services in providing a currency 
which is unsurpassed in its efficiency as a means of effecting 
the kinds of payments which are most important in modem business 

It was shown in Chapter VII that the cheque was especially 
adapted to carry through large and distant payments, and that 
the special advantages of this form of currency lay in the power 
to adapt each cheque in amount and in negotiabiUty to the needs 
of each particular transaction. There is no need to emphasize 
further the economies in the dispatch of business which result from 
the use of this currency and we need not anticipate the argument 
of the following chapters by examining the further advantages which 
result from the elasticity of its supply ; but something may be 
said on the subject of its supply price with a view to determining 
whether the issue of this currency, hke the issue of bank-notes, yields 
abnormal profits to the parties who supply it. 

The demand price for money, that is to say, the price which 
the pubHc pay for any given quantity, is evidently the same whether 
they draw their supplies from the banks or from the Mint ; it may 
be expressed in each case as the loss of interest on that part of their 
wealth which they hold in this form in order to effect their payments. 
This wealth may be kept at home in the form of sovereigns, or it 
may be lodged with a bank and employed for cheque-making 
purposes, in which case its price consists in the net rate of interest 
on the average balance of the account. 

So much for demand ; let us turn now to consider the expenses 
of production. The work involved in supplying a cheque currency 
is undoubtedly greater than that involved in the supply of bank- 
notes ; but the question remains whether the costs of production 
of the cheque currency are such that they enable the banks 
to obtain abnormal profits from their issues. When banks 
are able, without legal restriction, to issue large quantities of 
notes, their costs of production in the way of clerical labour, 


reserves and printing may be considerable, but there can be little 
doubt that they necessarily obtain profits which are abnormally 
high (cf. pp. 165-6). It is true that the Scotch banks obtain no 
direct net profit from their note issues ; but this, presumably, is due 
mainly to the legal restrictions imposed on them. In the case of 
the cheque currency it seems to be the fact that the banks do, but 
need not necessarily, obtain excessive profits from their issues. 

From the present point of view the essential fact is that the 
banker who supplies cheque currency, unlike the banker who 
issues notes, records his relations with each party using his 
currency in the form of an account, which is, or may be, the subject 
of a bargain between his customer and himself. The banker is 
immediately and always concerned that the cost of the work done 
in connexion with any current account should not exceed the net 
rate of interest on the average balance lodged with him ; on the 
other hand, the customer, if he is a business man, is usually con- 
cerned that the interest on this average balance should not be 
more than a fair price for the work- done by the banker in supplying 
lum with the services of the cheque currency. The work done 
by the banker is considerable. He has to maintain reserves and 
premises, to examine and collect cheques on other banks paid 
in by his customers, to examine and pay those drawn on himself, 
to pass those transactions through an elaborate system of books, 
to provide a copy of the customer's account in the form of a pass- 
book and to undertake a variety of miscellaneous services too 
numerous to state. Reducing these costs to some rough-and- 
ready measure, he examines his customers' accounts half-yearly 
or quarterly with a view to imposing his charges. From over- 
drawn accounts payment for work done is recovered by the 
imposition of a commission charge ; so, too, with an account whose 
average balance is insufficiently remunerative ; accounts whose 
balances are adequate escape any charge ; those whose balances 
are large in proportion to the work they involve may sometimes, 
as a result of a prior agreement, be allowed a small rate of interest. 
It must be recognized, however, that these are not the only con- 
siderations which determine the banker's charges ; he is likely 
to consider the nature of his customer almost as carefully as the 
nature of the account. These uninteresting details are stated 
with the sole view of emphasizing the fact that every current 
account may be the subject of a bargain which, by determining 
the size of the average balance, the charge of a commission, or 
the allowance of interest, can ensure that the banker obtains in 
each case only a reasonable return for his services ; in other words, 
that the cheque currency is supplied on terms which yield only 
a normal profit to the banker. It is no doubt the case that in 


actual practice, owing to imperfect bargaining between banker 
and customer, the banks often obtain excessive profits from 
lodgments on current account ; but increasing competition is 
undoubtedly reducing these profits, and consequently bringing 
the cost of the cheque currency into closer relation with the price 
at which in effect it is sold. 

The very high dividends on their paid-up capital which the 
EngUsh banks regularly distribute do not, of course, in themselves 
prove that the banks exploit their customers by charging unduly 
high prices for their services ; for the capital which they employ 
consists not only of their paid-up capital but also of their very large 
reserve funds and of the immaterial organization — the reputation 
and goodwill — which has a cost of production and must conse- 
quently yield a return. Nevertheless, it seems to be true that 
the traditional relations between banker and customer in many 
cases still hamper effective bargaining between the two, and so 
enable the banker to obtain for his services a price which is in 
excess of truly competitive rates. This imperfect bargaining, 
as has just been noticed, affects the price at which he sells the 
cheque-making facilities he supplies ; it affects also the price 
which he gets for his services as transporter of capital ; for, as 
was noticed in Chapter XXI, the rates at which he lends are 
somewhat lower in the North of England, where the relations 
between banker and customer are on a more strictly business 

The general conclusion, then, to which this discussion leads 
is that there is nothing in the nature of the services suppUed by 
the English Joint-Stock banks, whether in the provision of a 
currency or in the transport of capital, which necessarily results 
in their earning abnormally high profits on the full capital which 
they employ, but that in fact the profits which they obtain are 
somewhat higher than is necessary owing to the imperfect bargain- 
ing between them and their customers. 

This conclusion may need qualification in the near future, 
for it is tenable only so long as the present effective competition 
between the banks is maintained. What their future poUcy will 
be is a matter on which opinions differ ; but it seems unreason- 
able to suppose that the five great banks which now (1920) control 
the bulk of EngUsh banking business will long neglect the oppor- 
timity of entering into working agreements to reduce the dupUcation 
of banking offices and to market their suppUes at more profitable 
rates. In Scotland, according to Sir Charles Addis, competition 
has already been " practically eUminated by an arrangement 
between the eight principal banks not to outbid each other in the 
rates offered for deposits and advances." *« 


SO far we have proceeded on the assumption that the 
banking system is in equiHbrium ; that is to say, that the 
volume of cheque currency suppHed by the banks is just 
that amount which the pubUc need to carry through their 
payments at the normal level of prices. On this assumption the 
operations of the banks in collecting and distributing resources 
appear to be as simple and concrete as those, for example, of the 
Maypole Dairy Co., who collect their produce from many sources 
and distribute it by means of a system of branch establishments to 
their customers throughout the country. 

In fact, however, this equilibrium is rarely or never attained ; it 
is constantly being disturbed by changes in the Demand and Supply 
of currency, and the banking system is constantly adjusting itself 
to these changes and endeavouring to re-estabUsh the equiUbrium 
which has been disturbed. In order to investigate these conditions 
it is necessary to come closer to the actual facts ; in particular 
to consider the method by which the cheque currency is issued 
and the manner in which its supply is, and should be, controlled. 
In this investigation we are concerned only with a part of the 
banks' lodgments ; only with the volume of lodgments on current 
account which are employed for cheque-making purposes and which 
constitute the volume of the cheque currency. It will be convenient, 
therefore, to neglect altogether the lodgments obtained by the banks 
on deposit account, and to proceed for the present on the assumption 
that these resources are obtained only in exchange for cheque- 
making facilities. This assumption wiU not affect the substance 
of the argument, and will greatly simpHfy the wording. 

The first point to notice is the method by which the cheque 
currency is issued. In actual practice, as is well recognized, the 
supply of cheque currency, i.e., the volume of bank lodgments, 
is expanded and contracted by changes in the volume of bank 
loans. In the actual order of events loans precede lodgments and, 
in a certain practical sense, create them. The banks increase their 
loans by granting an extension of cheque-making facilities to 
borrowers ; the cheques drawn by these borrowers, being trans- 


ferred to other parties and paid by them into their banking accounts, 
reappear in the form of lodgments. An increase in loans is followed, 
therefore, by an increase in lodgments ; the banks lend more and 
their lodgments are still further increased. At first sight there 
appears to be nothing in the actual mechanism of the operation 
which need prevent this process from being continued indefinitely. 
In fact, however, there are limits actually set by the nature of the 
mechanism and limits which should be set by considerations of 
social interest. 

The first limitation arises from the fact that a persistent increase 
in the cheque currency (unaccompanied by a corresponding increase 
in the volume of money work to be done) increases the quantity of 
purchasing power in the hands of the pubhc and thereby raises 
the general level of prices, or, in other words, lowers the purchasing 
power of the sovereign. A fall in the internal value of gold, Uke a 
fall in the home value of any other commodity, encourages its 
export ; it leads also to a withdrawal of lodgments in the form 
of the legal tender money required for larger wage and retail 
payments ; and this twofold drain, by depleting the banks' 
reserves, compels a contraction in the volume of the cheque 

This tendency for gold, or any other thing, to flow outwards 
when its home value is relatively low, and to flow inwards when its 
home value is relatively high, constitutes a " natural " regulation 
common to all commodities. It is an automatic reaction which 
sets in, however, only as a result of a change in the purchasing 
power of the sovereign, that is to say, after the disturbance 
has occurred. 

This " natural " adjustment operates in the direction required 
by the social interest, but it operates crudely. Fluctuations in 
the value of most commodities are not of very great social import- 
ance, and these values are steadied sufficiently well by these 
" natural " influences which cause them to flow to the places in 
which they are in most urgent demand. But, even among ordinary 
commodities, these fluctuations may cause business disturbances 
sufficiently damaging to give some justification to deUberate regula- 
tion on the part of associations of producers, such as those which 
control the prices of steel products in this country. 

The case is far stronger as regards money. In the first place, 
the general practice of modem countries to multiply a central stock 
of gold into a far larger stock of credit currency for internal use 
carries with it the consequence that the volume of this currency 
is much more sensitive than would otherwise be the case ; for not 
only is this volume likely to vary arbitrarily with changes in the 
level of confidence, but it will also tend to vary largely in response 


to a relatively small change in the size of the central gold reserve • 
In the second place, the variations in the value of the sovereign 
introduce social disturbances so serious in character that, as Dr. 
Marshall expresses it, " it is worth while to do much in order to 
diminish them a little." For these two reasons, then, it becomes 
necessary to supplement the action of the crude "natural" pro- 
cesses of readjustment by a more conscious and delicate regulation 
of Supply. We need, then, to define the position of equilibrium 
which is required in the general interest, and to investigate the 
possibility of the adoption by the banks of a loan poHcy which 
would anticipate and prevent the effects of the various influences 
by which the equihbrium is being constantly disturbed. 

It has already been noticed that changes in the purchasing power 
of the sovereign set up a transfer of wealth which may, and often 
does, lead to serious social disturbances. It is quite conceivable 
that such changes might in certain conditions work for the social 
advantage. For the purpose of the present argument, however, 
it is not necessary to enter this debatable region and consider the 
manner in which the standard of value may be employed as an engine 
of social reform. It will give greater definiteness to the ideas, and 
will not be unfair if it is assumed simply that the social interest 
would be satisfied by maintaining the purchasing power of the 
sovereign as nearly as possible at a constant level. In order that 
this may be attained there must be a continuous adjustment of 
the volume of purchasing power to the volume of payments which 
it is required to carry through. On this understanding, then, the 
question to be dealt with is that of the part which can be played 
by the banks in maintaining this equilibrium between supply and 

Inasmuch as the banks supply only a part of the total volume 
of purchasing power, it is evident that there are limits to their 
power to control the value of the sovereign ; variations in this 
value which arise, for example, from persistent changes in the 
profitableness of gold mining must be almost entirely outside their 
influence. To what extent can they, then, employ their control 
over the cheque currency to maintain the purchasing power of the 
sovereign at a constant level ? It is clear, in the first place, that 
they should themselves refrain from disturbing this level by causing 
any contraction or expansion of the cheque currency which was 
not warranted by changes on the side of Demand. Further, as 
they have the power to vary the volume of this currency, they 
can endeavour to adapt supply to changes in the volume of money 
work. Finally, by judicious anticipation and counteraction they 
might intervene to check some of the temporary variations in the 
level, arising from causes which are outside their direct control. 


In order to consider what they do, and what they might do, in this 
way, we have to examine briefly the machinery by which the cheque 
currency is controlled, the manner in which the banks control it, 
and any defects in the machinery or in their policy which it is within 
their power to remedy. 


IF the banks are to take effective action to control the value of 
the sovereign, it is essential that the currency which they supply 
should be capable of being readily expanded and contracted, 
and that the power to effect these changes in its volume should 
rest mainly in their own hands. The first questions to be considered, 
then, are the elasticity of the cheque currency and the points at 
which this elasticity is controlled. 

With a purely gold currency, a continuous growth in the volume of 
money work would no doubt tend gradually to raise the value of the 
sovereign ; by so doing, it would stimulate the output of the metal 
from the mines and its withdrawal from the Arts, thereby increasing 
the quantity of gold available for money uses and checking the ap- 
preciation of the sovereign. But even in the unlikely event of 
" other things remaining unchanged " and time being given for this 
tendency to exert its full influence, its action would be likely to be 
feeble ; while during short periods of time such an automatic ten- 
dency to readjustment would be quite ineffective. In such circum- 
stances, therefore, as the only manner in which changes of Demand 
could be met would be by varying the efficiency of the currency, 
that is to say, by making each coin do more or less work than before, 
every change in the volume of money work, whether temporary or 
persistent, would be likely to cause a change in the purchasing power 
of the sovereign. When, however, the currency consists mainly of 
titles to gold which are a multiple of a central stock, it evidently 
becomes possible by varying this multiple, to adapt the volume of 
the currency to at least some of the constantly occurring changes in 
Demand. We need to consider briefly the organization by which 
this multiplication is effected. 

The stock of metal which this country takes from the inter- 
national market and employs as the basis of its issues of currency 
consists of the gold and silver held in the reserves of the Bank of 
England and the tills of the Joint-Stock banks ; for practical pur- 
poses, however, we may take this central stock to be represented by 
the reserve of gold and notes held in the banking department of the 
Bank of England. This is the all-important reserve on which the 



operations of the Money Market are based. There is no need, for the 
purposes of this argument, to use any but rough figures ; we may 
take the pre-war average amount of this reserve to be £30 m. The 
Bank of England, taking account of the demands for gold to which 
it may be exposed, of the private and pubUc obligation laid upon it 
to meet these demands and of the proportion which experience shows 
to be safe, lends against this reserve to the average amount of about 
£60 m. Of the lodgments so created some £20 m. are held by the 
Joint -Stock banks, and form, with their cash in hand and short 
money, the reserve which they, in their turn, may be regarded as 
multiplying into further lodgments. Their multiple, like that of the 
Bank of England, is determined mainly by what experience shows 
to be safe. In fact, the actual volume of lodgments resting on their 
reserves amounts to some £840 m., of which probably about £560 m. 
are the lodgments on current accoimts which constitute their issues 
of cheque currency. There is yet a further, but probably an un- 
important, multipUcation of this cmrency due to the fact that a part 
of these lodgments are held by smaller banks and employed by them 
as a basis for additional issues. Inasmuch as it is the normal pohcy 
of the banks to hold a certain definite proportion of their total lodg- 
ments in the form of short loans, of investments and probably also 
of till money, it is not unreasonable to neglect these kinds of reserves 
for present purposes and to consider that the reserve in the banking 
department of the Bank of England is normally multiplied by a 
definite figure into a much larger volume of cheque currency which 
forms the principal means of effecting payments. 

The link between these two amounts — the multiple which 
connects the reserve with the currency — is determined, as already 
noticed, largely by experience. This experience sums the effects of 
many influences which are the real determinants of the multiple : 
influences originating partly in the general social conditions in 
which the banking system operates, partly in the organization of 
the system itself (of. pp. 135-6). 

It is evident that these various influences are susceptible of 
gradual change as the social and banking organization develops, and 
that in course of time such changes bring about an alteration of the 
normal multiple and consequently an alteration in the volume of 
Supply. Further, a persistent decrease or increase in the output of 
gold from the mines, which results in a contraction or expansion 
of the central reserve, will result also after some Httle delay in a 
proportionate contraction or expansion in the volume of the cheque 
currency. These two sources of change — the secular alteration in 
the multiple and the automatic multipUcation of changes in the 
supply of gold — are important causes of variation in the supply of 
the cheque currency ; but for present purposes they may be neglected. 


for they cannot be eliminated or even greatly modified by any 
change in the loan policy of the banks. It remains true, however, 
that in order to meet temporary changes the banks' multiple can be 
varied ; that is to say, that the supply of cheque currency is elastic 
and is consequently capable of being adapted to changes in Demand. 
Before considering the loan policy of the banks, i.e. the manner in 
which they actually do vary this multiple, we have to ascertain at 
what points the power to vary the volume of the currency is lodged. 

Some measure of control over the supphes of purchasing power is 
exercised by the public. If their money work grows in volume they 
can increase the efficiency of the currency by working their accounts 
more intensively ; and, no doubt, when the outlook is good, 
business men actively employ that part of their money stock which 
in normal times they hold as a reserve against contingencies, and so 
increase the quantity of currency in active circulation. At such 
times, too, they can, if they choose, increase their power to draw 
cheques by transferring money from deposit to current account ; 
and they are likely to increase the volume of purchasing power by 
an extension of book credits. Promoters of new issues may even 
arrange for an importation of gold in order that bank loans may auto- 
matically increase and so make it more easy for them to float some 
new loan or joint-stock company. Conversely, the pubUc may, when 
their circumstances require it, withdraw legal tender from the banks' 
reserves and consequently cause a contraction of the cheque currency 
into which those reserves are multiplied. The public can, therefore 
exercise an appreciable measure of control over the volume of pur- 
chasing power ; they may increase or diminish it in a way which is 
largely independent of the banks ; and when they do so, they may 
initiate or reinforce a change in the value of the sovereign which 
increases the difiiculties with which the banks are faced in carrying 
out any policy designed to maintain that value at a constant level. 

It seems safe to assume, however, that the ability of the banks 
to vary the volume of their loans gives them sufficient power over 
the volume of the cheque currency to enable them to counteract 
minor disturbances due to the action of the public, and to effect a 
deliberate adaptation of supply to many of the changes in the 
volume of money work to be done. Each of the Joint-Stock banks 
in the system has the power to vary its multiple, and indeed it 
tends to do so when considerations of what is safe are modified by 
changes in the financial outlook which arise in the course of a 
business cycle. But, apart from such changes, its normal policy 
is to maintain its issues of cheque currency in a fixed and definite 
relation to its reserve, and to pass on to the Bank of England the 
task of regulating the volume of currency in accordance with the 
social interest. 


There are two good reasons why this duty should be lodged 
with the central bank of the system. In order to illustrate the 
first reason, let us suppose that a seasonal increase in the volume of 
payments has set up a demand for increased suppUes of cheque 
currency, and let us contrast the manner in which this demand could 
be met, on the one hand, by the Joint-Stock banks singly or in unison, 
and, on the other, by the central bank of the system. If one of the 
Joint-Stock banks were to expand its loans to meet a demand of 
this kind, no doubt some part of the cheques drawn against these 
loans would reappear as an increase in its own lodgments ; but 
naturally much the greater part would go to increase the lodgments 
of other banks in the system. The cheques paid into those other 
banks would be presented by them for payment through the Clearing 
House, and would require the bank whose loans had been increased 
to deplete heavily the balance at the Bank of England, which formed 
the most important part of its reserve. The net effect of the opera- 
tion, therefore, would be that the lending bank would obtain a sUght 
increase in its lodgments and would suffer a heavy reduction in its 
reserve, so that the multiple connecting the two would be altered 
unfavourably and in opposition to its normal policy of maintaining 
this multiple as a constant. Let us now suppose that all the Joint- 
Stock banks expanded their loans sUghtly to meet this temporary 
increase of demand. In such circumstances practically the whole 
of the cheques drawn would reappear as an increase in their aggre- 
gate lodgments, and their aggregate reserves at the Bank of England 
would remain unaffected. The net effect in this case, therefore, 
would be that the total lodgments of the banks would be increased, 
their total reserves would remain constant and the average pro- 
portion between the two would be affected in a sUghtly unfavourable 
way. But there would be no assurance that the change in the 
proportion would be the same for each bank ; in some the change 
might be large, in others it might be small. Even, therefore, if the 
Joint- Stock banks could agree to act in unison to meet this increase 
of demand, their policy would involve a considerable practical 
difficulty. This difficulty disappears when the central bank of the 
system undertakes to expand its loans to provide the additional 
currency which is required ; for the Joint- Stock banks keep their 
balances at the Bank of England, and consequently any increase 
in the loans of the Bank reappears as an increase in its own lodg- 
ments. The only difficulty experienced by the central bank in 
meeting a temporary increase of demand of this character Ues in 
the fact that an expansion of its loans involves a slight, but only a 
slight, unfavourable change in the proportion between its reserves 
and its lodgments. And this disadvantage soon disappears, for 
the Bank charges for its increased loans a rate of interest suffi- 


ciently high to ensure that they are repaid as soon as the pressure of 
demand declines to normal proportions. 

The central institution of a banking system is then in a peculiarly 
favourable position to regulate the volume of the currency, and a 
centralized system consequently carries with it the great advantage 
of a highly elastic supply. How important this advantage is, 
may be seen by substituting for the seasonal demand which has 
hitherto been assumed the intense demand for additional currency 
which arises during a period of crisis. During the American crises 
of the past this demand could not be met, for none of the many 
thousands of independent banks could safely expand its loans to 
provide business men with the currency they urgently needed to 
meet their obligations, and collective action could not be very 
effectively organized during the rapid growth of the emergency ; 
consequently the unwiUingness or inability of the banks to provide 
the public with the means of meeting their engagements increased 
the general apprehension and emphasized the severity of the crises. 

On the other hand, during recent periods of general appre- 
hension in England, the banking system, acting in harmony, has 
refrained from any general contraction of loans, while the Bank 
of England has undertaken to expand its issues of currency in 
response to the urgent public need. By such action public 
apprehension has been allayed and its development into a crisis 

In view of the ease and safety with which the central bank of a 
system can expand and contract its loans it is natural that the 
duty of regulating the volume of the currency should be entrusted 
mainly to the Bank of England. The Joint-Stock banks can and 
do meet local variations in the volume of money work by trans- 
ferring currency from one point to another in response to the 
seasonal needs of trade and industry, and in 1920 they are adopting 
a common policy of restricting the growth of their loans; but, 
generally speaking, they do not undertake the deliberate regulation 
of the total volume of supply ; this task, for the reasons given, 
they shift to the Bank of England. 

This, however, is not the only reason why the duty of regulation 
is passed on to the Bank of England ; a second reason arises from 
the extreme difficulty of ascertaining at any time the volume of 
currency which is really needed. 

The true social need for currency at any time is in theory per- 
fectly definite ; it is that amount which enables the public to 
deal with the volume of their payments without disturbances of the 
price level. But this amount cannot be found by direct inquiry ; 
it cannot, for example, be ascertained by the pressure of the public 
demand for bank loans, for this pressure is Ukely to increase at 


the very time when prices are rising in consequence of the currency 
being already in excess. 

In order to make this point clear let us consider the nature of 
the demand for an extension of bank loans during a period of rising 
prices and growing activity of business. This demand arises from 
the need of business men for increased quantities of resources as a 
means of expanding their operations ; these business men want to 
increase their capital in order to employ more labour, to increase 
their stock of raw materials and machinery, and possibly to increase 
that part of their capital which they hold as a stock of currency for 
effecting the increased volume of payments which accompanies 
the general expansion of activity. When, for example, a business 
man wishes to borrow £50,000 from his banker he may require to 
hold only £1000 of this as a money stock to carry through the 
increased volume of his transactions ; in which case only one- 
fiftieth of his demand arises from the true social need for currency. 
In response to this demand the banks cannot, of course, increase 
the quantity of real resources in the country ; aU they can do is to 
increase the supply of money, the supply of control over these 
resources, or Command over Capital. If a banker expanded his 
loans to meet the particular demand for £50,000 which we are 
considering, he would be acting against the social interest in respect 
of £49,000 at least, for he would be merely inflating the currency 
by that amount and so reinforcing the rise of prices ; and he would 
hardly be acting in the social interest in respect of the £1000, for, 
although by lending this amount he would be meeting a real need 
for the means of effecting payments, he would at the same time be 
enabUng the business community to maintain prices at the current 
level, which was already too high. 

The point to notice, therefore, is that the true social need for 
currency is expressed as a part of the demand for a control over 
resources in general ; it is not separately expressed in its own 
market, and its amount, consequently, cannot be found by direct 
inquiry in any market, or measured by the general demand for 
loans. Accordingly the supply of currency cannot be regulated 
by approximation to any known figure ; it must be regulated rather 
by correcting maladjustments after the event, in accordance with 
the signs of scarcity or excess, and by anticipating, with appropriate 
action, prospective sources of disturbance. These signs and 
portents are found in the movements of prices, the state of the 
foreign exchanges, the present and prospective strain upon the 
central gold reserve and many other of the vague indications 
which in their aggregate constitute the general financial outlook. 

It is clear that the Bank of England is in a far better position 
than the Joint-Stock banks to deal with a problem of this com- 


plexity. It is in close contact with the international gold market ; 
it holds the central gold reserve ; it knows the bankers' balances 
and the prospective movement of State funds ; moreover, its 
constitution is not representative of purely banking interests. 

This, then, is the second reason for the transfer of control to the 
Bank of England : that by virtue of its great prestige, of its re- 
cognition of the social interests entrusted to it and of its intimate 
contact with the many obscure influences which are constantly 
tending to set up changes in the value of the sovereign, the Bank 
is in a peculiarly favourable position to assume the responsibility 
for the regulation of the currency. 

We reach so far the following conclusions. The total volume 
of purchasing power exercised by the public includes a large and 
very important part consisting of the cheque currency. The volume 
of this currency may be regarded as a multiple of the central stock 
of gold held by the Bank of England. Both the public and the 
Joint-Stock banks have some power to vary the volume of the 
currency. But this power is not likely to be exercised in close 
conformity with the social interest ; for the public's action in this 
respect is largely irresponsible, while the policy of the Joint-Stock 
banks in normal times is to maintain a certain definite proportion 
between their lodgments and their reserves ; further, as the cheque 
currency is based on credit, there is a natural tendency for the 
power exercised by the public and the Joint-Stock banks to be 
influenced by changes in the general level of confidence, with the 
effect of causing variations of Supply which have no close relation 
to Demand. With these limitations, however, the greater part of 
the control over the currency is passed on to the central bank of 
the system, the Bank of Englai i, together with the duty of de- 
liberately regulating its supply in accordance with the social need. 
We have now to consider the machinery by means of which it 
discharges this duty. 


THE first point to consider in connexion with the 
machinery of regulation is the relation between the social 
interest, which hes in a greater stabihty in the value of 
the sovereign, and the practical pohcy of the Bank of 
England, which consists in maintaining its gold reserve at a certain 
necessary level. 

Causes tending to vary the purchasing power of the sovereign 
may originate at home or abroad. A fall in the home demand 
for currency due to a decline in the volume of transactions, or an 
increase of purchasing power in the hands of the pubUc due to an 
expansion of credit, both tend to cause a fall in the home value of 
the sovereign, to encourage the export of gold and consequently to 
reduce the size of the central reserve. Similarly, a temporary 
collapse of credit in a foreign country tends to make gold relatively 
dear abroad, to encourage its export from this country, to reduce 
the central reserve and consequently to cause a contraction of the 
cheque currency and a marked rise in the home value of the 
sovereign ; conversely, influences of an opposite kind tend to in- 
crease the central reserve of this country and, by leading to an 
expansion of the cheque currency, cause a fall in the home value 
of the sovereign. But all these causes, tending to disturb the 
purchasing power of the sovereign, whether originating at home 
or abroad, and whether working in one direction or the other, all 
express themselves in a tendency to vary the size of the central 
gold reserve. When, therefore, the Bank of England is carrying out 
its practical poHcy of maintaining its reserve at a certain necessary 
level, and is taking action against the causes which tend to disturb 
this level, it is also taking action against the causes which tend to 
disturb the home value of the sovereign. Its practical poHcy, there- 
fore, is harmonious with the social interest, and we may express 
its operations indifferently in terms of high theory or market 

To put the matter in a sUghtly different way : the Bank of 
England is the agency through which the banking system estab- 
lishes contact with the international gold market ; it constitutes, 


as it were, the channel connecting the external stock of gold in the 
world market with the internal stock which is multiplied for home 
use into a larger volume of credit currency. The object of the 
Bank, expressed in practical terms, is to take action against tem- 
porary causes which are constantly setting up an ebb and flow 
between these two stocks and so disturbing the level of the central 
reserve ; its object expressed in terms of the social interest is to 
react against the influences tending to disturb the value of the 

An association of producers formed to moderate the price 
fluctuations of the commodity in which they dealt would endeavour 
to carry out their policy either by directly regulating supply in 
accordance with changes in demand, or by varying the price at 
which they would from time to time be prepared to sell their pro- 
duct. The powers at the disposal of the Bank of England for the 
purpose of moderating fluctuations in the value of the sovereign 
are strictly analogous ; they are exercised partly by var3dng the 
supply of currency in response to changes of demand, partly by 
varying the rate at which this currency is from time to time supplied. 
The sole difference between the two cases lies in the fact that 
commodities are supplied to the public by way of sale, while 
currency is supplied to the public by way of loan. 

The first method has already been discussed ; apart from the 
1920 policy of collective control its successful use depends on 
the existence of a central bank and an elastic currency, both of 
which conditions are found in England. The Bank is able easily 
and quickly to increase the volume of its loans and consequently 
the volume of the cheque currency. It can, therefore, readily 
meet temporary expansions in the home demand which, apart 
from the action, would cause a rise in the purchasing power of the 
sovereign, and so initiate an import of gold. 

The second, and much the most important, method by which 
the Bank controls the movement of gold has also been discussed : 
it lies in the practice of varying the Bank rate. Such action becomes 
effective, it was noticed, through its influence on the Market rate ; 
for a rise in the Market rate has two consequences, the one im- 
mediate, the other more remote, but each operating in the same direc- 
tion. Its immediate effect is to make it more profitable than before to 
have fimds in London, so that an outflow of gold is checked and an 
inflow of gold encouraged. Its more remote effect, that is to say, 
the ultimate effect of a persistently high Market rate, is to con- 
tract the volume of bank loans and consequently of the currency, 
to raise the internal value of the sovereign and so to draw in gold 
from abroad. By the employment of this second method, there- 
fore, the Bank is enabled to meet temporary changes of pressure 


on its reserve, due to causes originating at home and more especially 
abroad, and by so doing to mitigate changes in the internal value 
of the sovereign which would result from any marked expansion 
or contraction of the home stock of gold. The point to notice at 
the moment is that the power of the Bank to take effective action 
of this kind depends on its abiUty to influence the rates of the 
great Joint-Stock banks by whom the greater part of the supply 
is controlled. Apart from collective action, a rise in the rates 
charged by the central bank works out its effects through several 
routes. By discouraging borrowing from the Bank itself, it tends 
to reduce the totals of Other Securities and Other Deposits, thereby 
initiating a rise in Market rates, directly through the contraction 
of loans, and indirectly through the contraction of the deposits 
which form the principal reserves of the Joint-Stock banks. It 
leads also to a partial rise in the rates at which capital is supphed 
throughout the whole country ; for a large and perhaps a growing 
part of the loans of the Joint-Stock banks are made at rates of 
interest which vary automatically with changes in the 0£&cial rate. 
Finally, each change in the Of&cial rate is customarily followed by 
a meeting of the Clearing House bankers, and leads usually, though 
not always, to a rise in the rates allowed by them to the pubUc for 
money lodged on deposit account. It seems to be true that a rise 
in Bank rate wiU always become effective if time is given for these 
various influences to work out their full results. But the Bank 
controls only a relatively small part of the total suppUes in the 
short loan market ; and the fact that it has at times to reinforce 
the influence of a rise in its rate by borrowing from the market 
shows that the Bank rate is inadequate as an effective means of 
dealing immediately with temporary disturbances. The lack of 
any close connexion between Bank and Market rates marks, then, 
a definite weakness in the power of the Bank of England to carry out 
the duties with which it is entrusted. 

It must be noticed, too, that the powers of the Bank to 
alleviate changes in the internal value of the sovereign are weakened 
by other causes. In the first place, the control exercised by the 
public and the Joint -Stock banks over the volume of the currency 
enables them to initiate or reinforce changes in the purchasing 
power of the sovereign which add materially to the difficulties 
which the Bank is called upon to face. In the second place, the 
very small size of the Bank's gold reserve in relation to its very 
large international habilities is itself a source of weakness, for it 
requires the Bank to react against disturbing causes more fre- 
quently and more violently than would otherwise be necessary. 
A substantial incrccise in the central gold reserve would make it 
possible to absorb many of the temporary strains set up at home 


or abroad, would make possible a more moderate employment 
of the machinery of the Bank rate and so would relieve the Money 
Market of many of the incessant minor disturbances to which 
it is in such circumstances exposed. 

We have then the following conclusions with regard to the 
machinery of regulation. Variations in the purchasing power 
of the sovereign are of such great social importance that an active 
policy of regulation is necessary in the social interest. Effective 
action of this kind is most conveniently taken by exercising de- 
liberate control over the volume of the cheque currency. This 
control is lodged partly with the public and the Joint-Stock banks, 
but mainly with the Bank of England. The Bank, emplojdng 
its power of regulating the volume of the currency in conjunction 
with its power of varying the market rate of discount, modifies 
the " natural " ebb and flow of gold between the internal and 
external stocks of the metal, thereby modifying also variations 
in the internal value of the sovereign. Its powers to carry out 
its duty in this respect smoothly and effectively are, however, 
weakened partly by the influence of the public and the Joint- 
Stock banks on the volume of the currency, partly by its imperfect 
control of market rates and partly by the relatively small size 
of its gold reserve. This brief consideration of the powers exercised 
by the Bank of England leads to the more difiicult question of 
the causes of the more important changes in the value of the 
sovereign, the ability of the banks to detect these causes and their 
power to modify their operation or their effects. 


BEFORE proceeding with the discussion of the particular 
questions laid down at the close of the last chapter, 
something of a more general character should be said 
with regard to the alternative methods by which paper 
currencies are regulated. 

We may begin with the fact that every note passed into circula- 
tion constitutes a loan free of interest raised from the public. 
It follows that those who supply these notes can obtain excep- 
tional profits on their operations {cf . pp. 147-8) and are consequently 
exposed to a strong temptation to issue them in excess. If this 
tendency works unchecked, it may impair public confidence in 
the note issue ; in any case, it will drive down the value of the 
unit of currency and so cause an upward fluctuation of prices 
which disturbs the conduct of home business and the course of 
foreign trade. In view of this disparity between private and 
social interest, it is only to be expected that Governments, where 
they do not themselves undertake the work, should impose re- 
strictions on those to whom they grant the right of issue. Their 
object in so doing is to protect the purchasing power of the unit 
of currency ; partly by maintaining the general acceptability of 
the note issue, but mainly by providing that its volume shall 
expand and contract, not in accordance with the impulse of private 
interest, but in response to the social need for the means of pay- 
ment. The principal method which they adopt to attain these 
ends is that of requiring banks of issue to hold a certain minimum 
reserve ; for if these promises to pay are always immediately 
convertible into gold, holders of notes are ensured against loss 
and at least a partial protection is obtained against over-issue. 

The Bank Act of 1844 partly effected these objects. The 
requirement that the Bank should hold a reserve of 100 per cent 
in gold against all notes issued beyond a certain defined minimum 
ensured the general acceptability of the note and effectively 
removed any temptation to over-issue ; but it also removed from 
the Bank any power to manufacture additional notes in response 

to temporary increases in the demand for money. That rigid 



restriction has, however, been a little modified by the Currency and 
Bank Notes Act, 1914, which allows the Bank, with the consent of 
the Treasury, to issue notes temporarily in excess of the legal limit. 
The various reserve requirements imposed on the Reichsbank prior 
to the war effectively ensured note-holders against loss, and so 
maintained the acceptability of the issue. The diversion of a 
part of the bank's profits to the State, together with the provision 
for a minimum gold reserve, removed the tendency to over-issue 
and partially secured the immediate convertibility of the note. 
At the same time special provision was made to enable the volume 
of the note issue to expand in response to temporary social needs. 

The recent reorganization of the banking system of the 
United States granted to the Federal Reserve Board the power 
of suspending the legal reserve requirements imposed on the 
banks within the Federal Reserve system, as circumstances make 
it desirable to do so. It marks, therefore, a partial transition from 
the condition in which Government defines in advance the limits 
within which the right of issue may be exercised, to one in which 
Government entrusts some expert body, conscious of the social 
interests involved, with full powers to regulate the supply of 
currency in response to changing conditions as they arise. Where 
the technique of banking is highly developed and the interests 
of the community are fully recognized, this latter policy is clearly 
the more flexible and effective method of regulation. It is success- 
fully adopted in France where the central bank, a semi-state 
institution with a conservative policy, has practically a free hand 
in controlling the volume of its issues. So too in this country, 
where the public responsibility assumed by the Bank of England, 
together with the great strength and high traditions of the English 
Joint-Stock banks, has made it possible for the State to entrust 
the banking system, without restriction of any kind, with the 
control of the deposit currency. It is with the manner in which 
the English banks exercise these powers that we are now 

In approaching the question of the principal sources of varia- 
tion in the value of the sovereign and the manner in which the 
banks employ their control over the cheque currency to modify 
these variations, we may first of all notice and set aside an 
important source of change which it is beyond their power to 

This cause, originating in the external gold market, has already 
been noticed ; it lies in a persistent change in the profitableness 
of gold-mining. When at the close of the last century the output 
of gold showed a marked and continuous increase, the new supplies 
of the metal, Hke those of any other commodity, distributed 


themselves among their various uses throughout the world at a 
continually declining value. Clearly the Bank could not check, 
and ought not to attempt to check, a corresponding decline in the 
home value of the sovereign. It was both necessary and desirable 
that a part of the new supply should permanently increase the 
central gold reserve and should be multiplied by the banking 
system into a volume of currency which would enable the general 
price level in this country to move upwards in correspondence 
with the general rise of prices throughout the world. Some of 
the effects of a persistent change of this kind may be alleviated 
by a judicious policy on the part of the banks ; but to remove 
the cause would require more drastic action, such as the abandon- 
ment of the gold standard and the adoption of another standard 
specially selected or devised with the object of providing a unit 
more stable in value. 

Setting aside this source of disturbance as being in the main 
outside the scope of the present argument, we may turn to consider 
those causes against which the banks can operate effectively : 
namely, the more temporary influences originating either abroad 
or at home. 

There is no need to consider at any length those causes which 
originate abroad, for the manner in which they operate and the 
manner in which they are met by the Bank of England have already 
been indicated ; but this is the appropriate place to deal with them, 
and something further may be said in spite of the repetition which is 
inevitably involved by so doing. 

The home value of every commodity is subject to disturbance 
from causes originating abroad : fluctuations in the foreign demand, 
speculative cornering of stocks, tariff changes and many other in- 
fluences are constantly altering the comparative level of internal 
and external prices, and so encouraging an inflow or outflow of the 
commodity affected. Further, when the change is due to such a 
cause as destructive dumping, the business disturbance which is set 
up by the temporary fall of price in this country gives rise to a 
demand for the deliberate regulation of importation. The social 
need which this demand expresses is evidently identical in nature 
with that which requires the Bank of England to react against 
temporary causes setting up a to and fro movement of gold. 

The home value of gold is subject to commercial causes of 
disturbances similar in kind to those affecting other commodities, 
but these causes are more various and are added to by others 
arising from the monetary uses of the metal. Gold, as a com- 
modity, has a market extending over the entire world ; being 
known and in demand in every country, it is subject to an immense 
variety of causes affecting its value, and being highly portable it 


tends to move rapidly from one point to another in response to 
these changes. . But over and above these sources of disturbance 
are those arising from its use as money. Gold enters into and is the 
duplicate of almost all transactions throughout the civilized world ; 
it is the unit in which almost all contracts are expressed, and conse- 
quently the unit by means of which these contracts may unfailingly 
be discharged. Accordingly any change in the volume of trade 
between one country and another is liable to set up a demand for 
gold for purposes of settlement and consequently to initiate a 
temporary change in its value. Further, the fact that most 
countries multiply a stock of the metal into credit currency for home 
use introduces additional sources of disturbances, for it exposes the 
value of the metal to changes arising from any local expansion or 
collapse of credit. It is evident, therefore, that the internal value 
of the sovereign is exposed to a vast number and variety of tem- 
porary external causes of disturbance ; there are the commercial 
influences, such as annual changes in the Indian demand for hoards 
or in the foreign demand for the use of gold in the Arts ; there are 
the influences arising from good and bad harvests and other causes 
of changes in the volume of trade which set up a demand for gold 
for the settlement of international balances ; and finally there are 
the influences originating in such conditions as a collapse of credit 
in a South American State or in the transition of a foreign country 
to a gold standard. All these influences exert their pressure with 
especial intensity on the reserve of the Bank of England, partly 
because England is the seat of a vast international trade, partly 
because she is the financial centre of the world and partly 
because London is in normal times the one great, free market 
for gold. 

Each of these temporary influences, if it operated unchecked, 
would be likely to cause a marked expansion or contraction of the 
Bank's reserve of gold and,- being multiplied by the banking system, 
would introduce a corresponding change in the home value of the 
sovereign with its accompanying social disturbances. In fact, 
however, it is not allowed to act unchecked, for the Bank reacts 
against it by means of variations in its discount rate designed to 
maintain its reserve at the level which it considers at the same 
time economical and safe. As already noticed, however, the fact 
that the Bank's reserve is unduly small and that its control over the 
market rate is imperfect causes the London Money Market and the 
main Produce Markets to be subjected to incessant minor dis- 
turbances which increase the business risks of their members and 
require the community to pay them for their services a higher price 
than would otherwise be necessary. 

The remaining causes which we have to consider are those 


originating at home in temporary fluctuations in the volume of 
money work and in changes in the level of credit. 

It is well known that the volume of payments, or the demand for 
money, may vary widely at different times in the year. This kind 
of variation is most cleariy marked in Germany. " The craze 
displayed after 1870 for uniformity did harm in abolishing the 
multitudinous dates for the payment of rent and interest and in 
substituting quarter day as the date of all payments of coupons, 
salaries, mortgages, etc. . . . Consequently on quarter days 
untold millions in bank-notes and ready money for redeemed and 
newly raised mortgages, rents and other pa5mients wander from 
hand to hand, only to return after a few days, in a roundabout way, 
to the same places where they have been made liquid (available)." *' 
In order to meet this temporary pressure greater elasticity was given 
to the Reichsbank's note issue in 1910 when the "tax free contingent " 
of £27^ m. was increased at the end of each quarter by £10 m. 

In France where over one-third of the population earn their living 
on farms it is only to be expected that there would be a heavy seasonal 
fluctuation in the demand for currency. The effects of the increased 
volume of payments to be carried through in the autumn are 
emphasized by the practice on the part of a large number of farmers 
of retaining a great part of their autumnal receipts in their own 
hands rather than depositing them with their bankers. In conse- 
quence of this there is a heavy pressure on the part of the pubUc 
to discount biUs and meet the deficit in the supply of currency. 
The Soci^t^s de Credit cannot meet this pressure because of the 
decUne in their deposits ; indeed, the total of their bills discounted 
is often at a minimum in the winter months. Accordingly the 
demand is passed on to the Bank of France, whose portfolio 
shows a marked seasonal fluctuation, rising at the end of the year 
to a figure some £35 m. above its minimum point. ^ 

The seasonal changes in the demand for currency in England 
have been described by Mr. Withers and many other writers ; they 
are matters of common knowledge. The demand by the Grovem- 
ment to pay its dividends, by householders to make quarterly 
rent payments, by business people to show a good balance-sheet 
at the end of March and December (the dates to which most of their 
accounts are made up) and by the general pubUc when making 
hoHday or buying Christmas presents ; all these temporary changes 
of demand fall on the Bank of England and are met partly by with- 
drawals of cash, but mainly by a simple expansion of the cheque 
currency. " By means of this sjTstem, emergency currency and 
credit are provided ^\dth extraordinary ease. It has grown auto- 
matically, commands complete confidence, and works with a per- 
fection that no theoretically planned scheme can rival. If the supply 


of money runs short, borrowers come to the Bank of England with 
securities of the kind it approves, and in the course of a few minutes' 
conversation with the principal of the discount office add a million 
or two to the basis of credit as expeditiously and easily as the ordinary 
citizen can buy a pair of gloves. The machine is a miracle of ease 
and efficiency." *^ The volume of cheque currency readily expanded 
in this way is as readily contracted when the need for it has passed, 
for the Bank charges a sufficiently high rate for additional supplies 
to ensure their early repayment when the pressure has declined to a 
normal level. It seems clear, therefore, that the loan policy of the 
English banks is admirably adapted to meet these temporary 
expansions in the demand for currency and that no appreciable 
disturbance results from their occurrence. It must not be over- 
looked, however, that they are in themselves causes tending to raise 
the purchasing power of the sovereign, and that if not met they 
would initiate an importation of gold and an increase of the central 
reserve which would be at least unnecessary and possibly a cause of 
further disturbance. 

It has been noticed that it is the normal policy of the Joint- 
Stock banks to maintain a certain definite proportion between their 
lodgments and their reserves. This policy is quite in harmony 
with the social interest when it is a question of meeting periodical 
expansions in the demand for money of the kind just described ; 
for if the additional supplies are not issued by the Joint-Stock banks 
they are obtained readily enough from the Bank of England. But, 
in the converse case, when demand falls temporarily below the 
normal level, this policy appears to be less well adapted to the 
general interest and even to be in conflict with it. For the volume 
of currency issued by the Bank of England is so small a proportion 
of the whole that in times when business is temporarily slack the 
Bank cannot by a simple contraction of its loans easily reduce the 
volume of currency to the level required by the social need. At such 
times, therefore, the continuance by the Joint-Stock banks of their 
normal policy leads to their maintaining a volume of lodgments in 
excess of the public requirements ; the currency is inflated not by 
an increase of supply, but by a fall of demand ; and it inevitably 
follows that loan rates in the London market fall to a nominal 
level. These unduly low rates influence people at home by en- 
couraging speculative activity on the Stock and Produce markets, 
and so giving a lift to prices ; they influence people abroad, for 
foreign countries find it less profitable to lend here and more profit- 
able to borrow ; these two effects reinforce one another, with the 
result that the balance of indebtedness turns against England 
and gold tends to flow abroad. We may perhaps conclude, then, 
that the policy of the Joint-Stock banks is defective in so far as 


their policy of regulating their issues by maintaining a certain fixed 
multiple of their reserves prevents the volume of currency from con- 
tracting in response to a temporary fall of demand, and consequently 
increases the difficulties of the Bank of England in protecting the 
central gold reserve. In reaching this conclusion we have arrived 
by a different route at the view expressed by Mr. Hartley Withers 
in his book on The Meaning of Money. In his chapter on Bank 
Rate and Market Rate, Mr. Withers points out the evils resulting 
from the grant of loans at nominal rates, and suggests that in such 
circumstances the banks should agree upon a common policy which 
should define the minimum rates at which they would lend, and 
would consequently reduce the total volume of their loans. 

The Joint -Stock banks are managed by business men who 
administer the resources at their disposal on ordinary business 
principles. There are practical reasons which tend to prevent 
any one bank from contracting its multiple during periods of 
temporary business slackness, for each naturally endeavours 
within the limits of safety to maximize its individual profit, and 
it would not do so by a contraction of its loans unaccompanied by 
a corresponding contraction on the part of the other banks. There 
are, similarly, practical reasons which tend to make each bank 
increase its multiple during the more prolonged periods we have 
now to consider : the periods of rising confidence which accom- 
pany, and indeed cause, an expansion of credit. It would be 
unreasonable to expect that a practical policy designed to maximize 
individual profits should in all circumstances lead the Joint-Stock 
banks to act in perfect harmony with the social interest and, indeed, 
in the circumstances which we are considering it may be argued 
that it leads the banks to act in a manner which increases the 
difficulties of the Bank of England in protecting the interests of 
society as a whole. 

Let us assume, without inquiring into the cause, an improvement 
in the business outlook which results in a rise in the general level 
of confidence throughout the business community ; and let us 
endeavour to trace, first, the manner in which this change is magni- 
fied in its transmission through the monetary system, and, secondly, 
the manner in which the banks might employ their control over 
the cheque currency to react against its injurious social effects. 

The active principle determining the development of a business 
cycle seems to lie in the inherent instability of business confidence ; 
in its tendency to rise or fall cumulatively ; in the fact that it has 
a " normal level " only in the sense that during the transition from 
moderate depression to moderate exhilaration the level of confi- 
dence is neither abnormally high nor abnormally low. This principle 
is not an ultimate cause ; it originates partly in the nature of the 


industrial organization, partly in the nature of the monetary 
sjTstem. The organization of the typical producing group, which 
causes the entrepreneur to obtain a bounty from rising prices ; 
the length of the interval between the initiation of the production 
process and the delivery of the finished goods, which causes 
output to depend not on facts but on forecasts ; the imperfect 
knowledge on the part of each producer of the activity of his rivals, 
which increases the uncertainty of these forecasts ; the period of 
time required for the construction and wearing out of capital goods, 
which hampers the rapid adjustment of the appliances of produc- 
tion to the demand for their products ; the close interrelation, 
financial and commercial, of all kinds of business activity — all these 
industrial conditions cause changes in business confidence to be 
cumulative ; and they are reinforced by accompanying changes in 
the volume of purchasing power. 

Let us, then, suppose that, in a period of general depression, 
there occurs a change which improves the business outlook in some 
particular trade, and so causes business men in that trade to be 
more confident that any goods they may now begin to produce 
will be marketable at more profitable prices. Whether or no this 
confidence is justified, the increased activity in the trade concerned 
will be a real cause of increased confidence on the part of many 
other producers. For this increased activity will be propagated 
backwards, forwards and sideways ; it will increase the prospects 
of profitable sales for producers of its raw materials, for the trans- 
port and merchanting agencies which deal with its materials, and 
for the trades which supply the goods on which the larger earnings 
of its workpeople will be expended. Each trade so affected will, 
in its turn, pass on and return the impulse. In this way rising 
prosperity and growing confidence in each trade is a cause of rising 
prosperity and growing confidence in all others ; the influence is 
mutual and cumulative. The constructional trades, together with 
the producers of coal and iron, become exceptionally busy ; business 
activity increases generally, and productivity expands. 

This cumulative activity is reinforced by its effects on the 
monetary system. Increasing confidence inevitably encourages 
business men to extend the investment of resources in their under- 
takings in order to take advantage of the more favourable business 
opportunities open to them. It is likely, therefore, that they will 
bring into active circulation that part of their money stock which 
they normally hold as a reserve against contingencies ; investors, 
by releasing their accumulations, will further increase the quantity 
of money in active circulation ; merchants and speculators will 
buy goods for future delivery with bills of exchange or mere promises 
to pay, as they did with such powerful effects in 1919. Individual 


action of this kind results in the creation of an increased quantity 
of purchasing power which, being employed to hire more labour 
and to obtain more raw materials and finished goods initiates (or 
emphasizes) a rise of prices. 

But rising prices, in the existing organization of society, grant 
a bounty to the employer, and consequently reinforce the rising 
level of confidence, and urge business men to obtain more capital 
in order to expand still further the scope of their activities. 
CapitaUsts, encouraged by the growing prosperity of trade and 
industry, are more wiUing than usual to lend ; business men are 
more urgent than usual in their demands for resources. Capital 
flows readily into the hands of the company promoter to expand 
joint -stock enterprise of all descriptions, and there sets in a heavy 
pressure on the Joint-Stock banks for an extension of their 

It would be an extraordinary thing if the banks alone, among 
business men, were imaffected by the general spirit of confidence, 
and if they were not inclined to feel that a proportion between 
lodgments and reserves which was safe in ordinary conditions was 
not rather more than safe in a period of increasing prosperity. No 
doubt in the later stages of the upward movement there are symptoms 
of approaching difi&culties which they will not disregard, and no 
doubt cautious bankers will throughout discriminate against 
dubious securities of the nature of finance bills. But in the earlier 
stages the Joint-Stock banks have every inducement to expand 
their loans : they must feel it safer than usual to do so ; they can 
lend against good security at unusually profitable rates of interest ; 
and they probably regard it as their duty to meet what they regard 
as the " legitimate demands " of business. 

But the banks can lend only " Command over Capital '* ; they 
cannot increase the supply of food, raw materials, machinery and 
other real capital which is required. Every increase in their loans 
means an increase, not of real resources, but of control over these 
resources ; it means a dilution of the currency, and involves a 
further fall in the purchasing power of the sovereign or, in other 
words, a further rise in the general level of prices and a yet further 
artificial stimulus to trade and industry. At such times, when the 
purchasing power of the community has already been increased by 
action on the part of the public, and rising confidence has been 
reinforced by rising prices, it seems probable that the true loan 
policy of the banks lies not in an expansion of their loans, but 
rather in a contraction designed to counteract the effects of increased 
purchasing power on the level of prices ; or, if such drastic action 
is impracticable, it would seem to be a poUcy which enabled them 
to lend in support of " legitimate " business, but to lend only at 


rates so high as to take from business men the bounty conferred 
on them by rising prices. 

Professor Irving Fisher has shown that the money rates of 
interest charged by the banks at such times are below the real 
rates ; they are, therefore, much below the level at which they would 
destroy the bounty accruing to business men, for that bounty is 
derived in part from the working man as a result of the comparative 
fixity of wage rates. But the extent to which the English Joint- 
Stock banks actually expand their loans during such periods is a 
matter rather of inference than of statistical proof. The opinion 
of bankers, the evidence from foreign banking systems so and the 
strong a priori considerations which have been indicated all point 
to the conclusion, however, that their loans are considerably expanded 
during periods of increasing activity of business, and consequently 
that their policy, so far from counteracting the social disturbances 
due to a rising level of confidence, emphasizes these effects and 
increases the difficulties to be dealt with by the Bank of England. 

The rising prices, which are in a large measure the cause of the 
feverish activity of business, carry within them the cause of its cure ; 
for the falling value of the sovereign in this country works more 
and more strongly to encourage the export of gold and a withdrawal 
of legal tender money to carry through the larger volume of wage 
and retail payments. But before this tendency has shown itself 
strongly in an internal or external pressure upon the banks' reserves, 
or, at any rate, before the Bank of England can react effectively 
against the rising prices by reducing the volume of the currency, the 
normal adjustments of trade and industry may have become 
seriously disturbed. The great ease with which large profits can be 
made during periods of rising prices leads almost inevitably to a 
reckless use of resources : many businesses, particularly those manu- 
facturing durable plant, will have expanded their productive ca- 
pacity and their output in response to a rise of demand which cannot 
be sustained ; the public will have subscribed much capital, and 
undertaken to subscribe more, for the formation of new Joint-Stock 
companies, many of which will yield a profit only to the promoter ; 
speculators will have driven the prices in many markets to extreme 
levels, and by carrying stocks with the aid of borrowed money and 
promises to pay will have weakened the power of the market to meet 
any decline of values. The principal financial aspects of this con- 
dition will be the great extension of mutual indebtedness and a 
level of prices abnormally high. When, in those circumstances, 
confidence is weakened, either by industrial or financial causes, 
and bankers begin to restrict their loans, prices cease to rise and 
confidence in the immediate business outlook inevitably declines 
further. Business men, following the lead of the bankers, endeavour 


to strengthen their position by increasing their stocks of money ; 
the pressure to sell increases, while the pressure to buy falls off ; 
prices fall and confidence declines more rapidly ; there sets in a 
heavy demand on the banks for the additional supplies of money by 
means of which outstanding liabilities may be met — a demand which, 
if unsatisfied, may become a panic demand and precipitate a crisis. 

At such times of rapidly declining confidence, when the public 
need for currency as a reserve against contingencies and also per- 
haps to meet an increased volume of current transactions is excep- 
tionally heavy and urgent, there is naturally a strong tendency on 
the part of each individual Joint-Stock bank to strengthen its position 
by contracting its loans, and by so doing to contract also the supply 
of cheque currency. It is now generally recognized, however, that 
if each individual bank endeavours to protect itself in this way, each 
is merely increasing the pressure falling on all ; that at such times 
the banking system, being based on public confidence, is threatened 
as a whole ; and that this confidence must be maintained by col- 
lective action. In recent periods of strain, therefore, joint action 
by the large banks has restrained the tendency of individual institu- 
tions to call in their loans and so decrease the volume of the currency. 
This action has been effective in so far as it has succeeded in prevent- 
ing crises, but it has probably not been effective in inducing each 
individual bank to assume its fair share of responsibility. It has 
shifted on to the Bank of England the duty not only of meeting the 
additional currency needs, but also of meeting the deficit caused by 
contraction on the part of others. 

The argument of this chapter is an attempt to examine the 
actual loan policy of the banking system based on an effective 
gold standard and to indicate any modifications which are desir- 
able in the social interest ; the conclusions to which it points 
are these. The ideal policy, it is assumed, is one by which the 
banks would react effectively against temporary causes tending 
to disturb the purchasing power of the sovereign. Those causes 
which arise from fluctuations in the external demand for gold are 
dealt with by variations in the Bank rate; but they are pro- 
ductive of minor disturbances in the Money Market which could be 
lessened if the Bank rate were more effective and the central reserve 
larger. Those causes which originate in such conditions as a 
seasonal expansion of the home demand for currency are met quickly 
and easily by the Bank of England ; but those proceeding from a 
temporary decline of demand produce minor evils which could be 
reduced by collective action on the part of the Joint-Stock banks. 
By far the most serious causes are those associated with the expan- 
sion of purchasing power accompanjdng and reinforcing those 
changes in the level of confidence which are responsible for cyclical 


fluctuations. It would appear that the present poUcy of the Joint- 
Stock banks reinforces the upward movement of prices, but that it 
would be within their power, and very greatly to the social advan- 
tage, for them to employ their control over the cheque currency to 
react against the expansion of purchasing power and modify if not 
destroy the artificial stimulus which it gives to business activity. 

It may be objected that, as Dr. Marshall states, " almost every 
recent wave of high or low commercial activity has spread, not very 
unevenly, over all countries in which large scale capitalistic produc- 
tion has prevailed," ^^ and consequently that the power of the banking 
system in any single country to moderate their intensity is rather 
more limited than has been assumed. This argument may show 
that a universal disturbance can be fully met only by universal 
action ; but it does not weaken the case for each country doing what 
it can to reduce the share of the general evil borne by itself. Past 
experience in this country shows clearly that banking policy can 
materially reduce the severity of business cycles, and post-war 
experience, so far as it is relevant, seems to confirm the effectiveness 
of individual action in the control of price levels. 

It may further be objected that if the banks took stronger action 
to restrain the upward movement of prices during the earlier stages 
of a business cycle, they would retard the growth of business, the 
expansion of profits and the rapid development of the capital equip- 
ment of the country which occur during these periods. It is no 
doubt true that a partial removal of the artificial stimulus of rising 
prices would reduce the rate at which production expanded ; but 
it would also reduce the wasteful application of resources, the 
intensity of crises and the volume of unemployment which accom- 
panies the subsequent period of depression. This objection may 
then be met. It does not affect the substance of the argument ; 
but it indicates the extreme complexity of the problem, and shows 
that the degree in which the loan policy of the banks might advan- 
tageously be modified depends on a valuation of all the good and 
evil involved in a trade cycle. 


ALTHOUGH the fundamental services of the Enghsh Joint- 
Stock banks are quite simple in character, their examina- 
tion has given rise to a variety of special problems each one 
of which it has been necessary to discuss from its own ap- 
propriate point of view under penalty of losing touch with ordinary 
business language and ideas. In the course of these special dis- 
cussions it has been difficult to preserve the unity of the main 
argument ; hence it seems worth while, even at the cost of con- 
siderable repetition, to retrace the main lines of this argument in 
order to bring into closer relation with one another the main con- 
clusions which have been reached. 

The principal difficulty in understanding the operations of the 
Enghsh system seems to arise from the circumstance that the system 
is carrying out, at the same time and in intimate connexion with 
one another, two operations which are fundamentally distinct in 
character. The transfer of money and the manufacture of money — 
in other words, the Transport of Capital and the Supply of a Currency 
— are operations which are different in nature, are influenced in their 
development by different conditions and are to be judged by 
different standards. In these circumstances it seems impossible 
to form any clear conception of the work done by the system except 
by a separate examination of the two services it supplies. 

The service of transporting capital (or more properly Command 
over Capital) is in essentials independent of the nature of the 
currency and could be quite well dealt with on the supposition 
that the money stock consisted only of gold pieces — could be 
dealt with, that is to say, without reference to the fact that the 
banking system also undertakes the manufacture of cheque 
currency. In view, however, of the fact that the use of a cheque 
currency contributes directly to the efficiency of the work of 
transporting capital by enabhng the banks to transfer resources 
from point to point cheaply and rapidly, it has been more con- 
venient to adhere to actual conditions, in which the cheque forms 
the principal means of payment. But in order to isolate the 
service of transporting capital it was necessary to eliminate that 



part of the banks' work which is concerned with variations in the 
volume of the cheque currency and in the volume of payments 
it is required to effect, and proceed on the assumption that the 
amount of cheque currency supplied was just that amount required 
to enable people to effect the current volume of payments at the 
normal level of prices. 

That being assumed, the economies introduced by this part 
of the banks' work were measured by a simple standard : namely, 
the effect of their operations in increasing the earning capacity 
of capital. Their operations contain three economies. 

In the first place, they increase the supply of capital by collect- 
ing lodgments from the public, partly in exchange for a rate of 
interest, partly in exchange for cheque-making facilities ; secondly, 
by compounding these lodgments with their own capital and 
reserve funds, they convert a large number of small quantities 
and short lengths of capital, individually ineffective, into an aggre- 
gate available for productive employment ; finally by a continuous 
redistribution of this capital among the points of highest yield 
they maximize its earning capacity. 

The volume of their work and the efficiency with which it is 
discharged depend partly on external conditions, partly on the 
character of the banking system itself. The normal level of their 
lodgments is evidently determined by the size of that part of their 
resources which the public lodge with them on deposit account 
by way of a readily available investment and by that further 
part which they lodge on current account in exchange for cheque- 
making facilities. Such influences as an increase in the wealth 
of the people or an increase in the volume of payments effected 
by cheques tends, therefore, to increase the total volume of lodg- 
ments ; while such influences as the development of stock exchange 
securities and other alternative methods of investing resources 
and providing reserves against contingencies tend to check the 
growth of lodgments. The principal influences due to the nature 
of the banking system are the scope of the branch bank organiza- 
tion, the centralized character of the system and, most important 
of all, the great reputation and strength of the individual banks. 
For on these considerations depend, first, the willingness of the 
public to entrust the banks with a large part of their resources ; 
secondly, the fraction of this amount which must be held in the 
form of reserves, and hence, finally, the portion of these resources 
which the banks can make available for productive employment. 
In 1913 the banks owed the public some £840 m., and increased 
the productive efficiency of these resources by an amount in the 
neighbourhood of £20 m. a year. 

We have summarized the economies resulting from the banks' 


work of transporting capital in the light of the fact that the money 
stock of the community consists mainly of cheque currency, and 
on the assumption that the amount of this currency was properly 
adjusted to the demand for it. Let us for a moment retain this 
assumption and add the further economy arising from the service 
performed by the banks in supplying cheque-making facilities in 
exchange for the use of resources lodged by the public on current 
account. It is impossible to evaluate this further economy in 
terms of money, but it is clear that the work done by the banks 
in substituting for alternative forms of money the extremely 
convenient cheque currency appreciably facilitates the economical 
dispatch of business, especially by its effects in enabling distant 
payments of large and irregular amounts to be made with ease and 

These economies being added together in this way, the aggregate 
constitutes the principal normal economies of the English banking 
system : that is to say, the economies yielded by the system in 
equilibrium — the economies which would appear if the more 
persistent influences governing banking operations were allowed 
to work out their full effects without interference. In this con- 
dition of equilibrium banking operations are very simple. The 
banks are middlemen ; on the one hand, borro\\ing capital, either 
for an interest payment or for services rendered, and, on the other 
hand, carrying this capital into the hands of those who bid the 
highest net rate for its use. The public lodge with them Command 
over Capital, a control over a specific fraction of the productive 
resources of the community, and this fraction, plus their own 
resources and minus their reserves, governs absolutely the volume 
of their loans. 

This simple picture is radically transformed, however, when 
we abandon the assumption made hitherto and take account of 
the influences which are constantly tending to disturb this equili- 
brium : namely, the changing demand for cheque currency and 
the fact that the banks have the power to vary the volume of 
this currency at will by varying the volume of their loans. The 
introduction of this new set of conditions requires us to judge 
the operations of the banking system by another quite different 
standard — the degree of success which the banks attain in so 
adjusting the volume of their loans as to approximate as closely 
as possible to the equilibrium which has been described. 

In approaching this question we provisionally define the ideal 
to be attained as an adjustment in which the value of the unit 
of currency, the sovereign, is maintained at a constant level. 
The most effective method of attaining this ideal is, no doubt, 
the adoption of a tabular standard of value with machinery for 


maintaining the value of the unit of currency in conformity with 
it. If, however, so radical a change is practically unattainable, 
it is necessary to consider what other methods may be employed 
in existing conditions to attain the same end. 

An alternative method is one by which the banks would de- 
liberately employ their control over the cheque currency in order 
to adjust the total supply of purchasing power more closely to 
the volume of money work and so diminish the fluctuations in the 
purchasing power of the sovereign. This they already do ; for 
the policy adopted by the Bank of England is perfectly harmonious 
with the attainment of this object. But it is suggested that they 
might do more : a more conservative loan policy during periods 
of growing business activity would diminish the severity of 
business cycles ; a joint restriction of loans when money is unduly 
" cheap," owing to a transient decline in demand, would reduce 
the disturbances due to temporary inflation ; while a larger central 
reserve and a closer connexion between Bank and Market rates 
would diminish price fluctuation in the Stock and Produce Ex- 
changes and the risks of borrowers and lenders in the short loan 

This second service of the banking system is then to be judged 
partly by the technical efficiency of the currency with which it 
supplies the public, partly by the manner in which it exercises 
its control over the volume of this currency in order to lessen the 
effect of influences tending to change the home value of the 

Granted, what appears to be true, that the banks are in effective 
competition with one another, there is evidently nothing in the 
nature of the work of transporting capital which necessarily 
involves the earning of abnormal profits. The same conclusion 
appears to be true with regard to the supply of a cheque currency ; 
for the conditions of supply are such as to enable a fair bargain 
to be struck between the banker and his customer. But although 
it appears quite possible for those two services to be supplied at 
prices corresponding to costs of production, it seems, nevertheless, 
to be true that in actual conditions imperfect bargaining between 
banker and customer leads to their being supplied in part at prices 
which yield the banks a rate of profit rather above the necessary 

It is not to be supposed for a moment that bankers administer 
separately, or even consider separately, the two services which 
they supply ; they deal with the matter as a whole. If, therefore, 
theory is to follow and explain practice some attempt must be 
made to bring the influences affecting those two services into unity. 
They may be unified in terms of loan policy ; for whether a bank 


is transferring resources or providing a currency, it is engaged in 
supplying Command over Capital. 

With that aspect of the banks' loan policy which determines 
the manner in which a given quantity of resources is distributed 
among its various employments, we are not now closely concerned. 
The work calls, no doubt, for judgment, caution and an intimate 
knowledge both of the nature of the borrower and of the quality 
of the security he offers ; but it raises no particular difficulty of 
theory. The policy is only a refined application of the general 
principle on which every business man distributes his capital 
among its various uses (pp. 30-1). Experience of what is safe and 
profitable is embodied in a policy of maintaining, normally, a certain 
definite fraction of total lodgments in each of various kinds of 
reserve. When, however, we turn to consider banking policy in 
relation to changes in the aggregate volume of loans, the matter 
becomes more complicated ; for this volume is governed partly 
by the influences affecting the transfer of capital, partly by the 
influences affecting the supply of currency ; and it is not always 
easy to disentangle and interpret their effects. 

Neglecting the paid-up capital and reserves of the banks, there 
are two fundamental influences determining the amount of Command 
over Capital which they can supply. The first arises from the 
general conditions which determine the quantity of real resources 
which the public are prepared to transfer to the control of the 
banks. In England they so transfer, partly by way of a convenient 
investment, partly in exchange for cheque-making facilities, a 
control over about one-fifteenth of the total wealth of the country. 
The second influence is that governing the money value of these 
resources ; the larger the total stock of gold and other legal tender 
money, the larger are the figures representing the resources trans- 
ferred to borrowers. Changes in the wealth and habits of the 
people, and persistent changes in the annual suppUes of gold, 
gradually change, therefore, the volume of bank loans. During 
the war, of course, an emergency banking policy and a great 
increase in legal tender money have greatly and rapidly altered 
the money value of the resources the banks control. 

But while in the long run the volume of bank loans is determined 
mainly by the will of the public and the output of the mines, during 
shorter periods of time it is governed to an important extent by 
the will of the banks themselves During the upward course of a 
business cycle the banks expand their loans ; they transfer to 
borrowers a control over resources greater than that lodged with 
them by the public. For, by creating Command over Capital, 
they lower the purchasing power of each unit of currency in the 
hands of the pubhc and, in effect, make a forced levy on the 


community for the benefit of those who borrow from them. But with 
an effective gold standard this expansion of the currency, in so far 
as it is in excess of the money requirements of the community, can 
be maintained only temporarily. It ultimately leads to a drain 
upon the central reserve which compels a contraction of loans. 

Transient fluctuations in the supply of Command over Capital 
are naturally expressed in the form of transient changes in that 
part of the banks' loans which are readily recoverable ; they are 
concentrated mainly on the short-loan market. The volume of 
these loans is governed by the quantity of resources which the 
public choose to lodge with the banks, by the proportion of those 
resources which the banks find it advisable to lend for short periods, 
and by the incessant minor changes whose impact is absorbed by 
changes in the volume of short -loan money. These changes arise 
in part from such causes as the temporary " lock up " of funds due 
to payment of calls on new issues, and the desire of the banks to 
show large reserves in their half-yearly balance sheets. But they 
originate mainly in influences which affect the loan policy of the 
Bank of England, and consequently the basis on which the loans 
of the Joint-Stock banks rest. Such influences are variations in 
the financial outlook, in particular the movement of gold to and 
from the country ; the seasonal expansion of the Bank's loans in 
response to increased demands for currency ; the transfer of tax 
receipts to Public Deposits, and their release in payment of dividends. 
These influences have been overshadowed during the war by the 
policy governing the issue of Treasury notes. They are likely to 
be dominated for many years to come by the exigencies of public 
finance : by variations in the volume of State borrowing from the 
market and especially in the pressure of the State demands upon 
the Bank of England. These variations in the supply of Command 
over Capital cause fluctuations in prices and alternations in business 
activity which are closely similar in nature to those arising from 
the more persistent and general changes which have been discussed. 
But their influence is both temporary and local. They operate 
in a world which is, as it were, a model of the wider market, reduced 
in time and space. 


New Securities 

IT was noticed on pages 122-3 that the market for Stock 
Exchange securities is separable into two distinct but inter- 
dependent parts : the one, dealing with the marketing of new 
securities, facilitates the transfer of new capital from capitalists 
to entrepreneurs and other parties ; the other, dealing with the 
marketing of old securities, facilitates the transfer within the group 
of capitalists of the titles to the capital outstanding in the hands 
of "these entrepreneurs and other parties ; together, the two parts 
lower the price at which capital is supplied to those who bid for its 
use. It is with the first part of this organization that we are now 

This market is composed of the whole of the organization engaged 
in the creation and sale of new negotiable securities ; using that 
term to include transferable titles to property such as shares and 
stocks, and transferable evidences of indebtedness such as de- 
bentures, bonds, and municipal and Treasury bills, but excluding 
the bills of exchange whose market is formed mainly by the banks 
and the bill-brokers. 

In Germany the sale of these securities is undertaken mainly 
by the banks ; in France it is dealt with to a considerable extent 
by the Haute Banque, the great Credit Societies and local bankers. 
In England, however, it is broadly true that only the better classes 
of securities are marketed by specialized institutions of this kind. 
Here the marketing organization is, as a whole, much less definite 
in form ; it includes a wide range of agencies extending from the 
small group of firms of high reputation who specialize in this work, 
down to the innumerable little ad hoc promoting groups, in London 
and throughout the Provinces. 

Foremost in this organization are the Issuing Houses proper, 
composed of highly reputable firms like Rothschild, Schroeder 
or Seligmann, whose main work lies in marketing such securities 
as those of foreign Governments and railways. It is, perhaps, possible 
to distinguish as a second and separate group a number of Trust and 

Finance Companies and of small firms sometimes described as Issuing 



Houses, the distinction being made on the ground that they are 
permanently engaged in financial operations, and that, having a 
reputation to lose, they give the public some measure of assurance 
of the worth of their issues. Finally, comes that part of the 
organization by means of which the great bulk of joint -stock com- 
panies are floated : namely, the ephemeral promoting groups, 
usually specially formed for the purpose of selling a venture to 
the public, and dissolved when that purpose has been carried out. 

These three groups may perhaps be regarded as forming the 
centre of the market organization ; but work similar to theirs is 
undertaken by other parties. Municipalities may assume the 
responsibility of selling their own stocks either locally or on the 
London market ; railways may act in a similar way ; while joint- 
stock companies of all descriptions may themselves undertake to 
sell additional issues of their shares or debentures by offering them 
to their shareholders, by advertising them in the local press or by 
employing agents to place them among the public. American 
industrial securities used even to be hawked from door to door in 
this country, and a similar practice obtained a short while ago 
in Germany. 

These are the parties who assume the responsibility for the work 
of issue ; associated with them are others who specialize in some 
part of it. The more important of these are the underwriters, 
among whom are included many of the banks, the Trust and Finance 
Companies, Insurance companies and financiers of all descriptions ; 
the brokers, who lend their names to the prospectuses, assign the 
underwriting on payment of an " overriding " commission, carry 
througfh many of the technical formalities and open up a market 
among their clients ; the bankers who receive subscriptions from 
the public and issue securities in exchange ; and the advertisement 
houses whose specialized machinery may enable them in some 
cases to distribute a million prospectuses in a day among a selected 
public,^'^ together with the experts who draft an attractive pros- 
pectus and arrange for advertisement and notices in that part 
of fhe financial and general press which is appropriate to the 
particular issue. 

Specialization is naturally carried further in London than else- 
where ; but marketing organization more or less developed in 
character extends all over the country. Although indefinite in 
form, it is immensely powerful in action. Its principal device 
consists in expressing the demand for capital arising from public 
bodies and business undertakings in the form of a very large number 
of negotiable titles such as ordinary and preference shares and 
debenture stock, these securities being adapted both in amount 
and in the degree of risk concentrated upon them to the needs of 



all classes of investors (cf. p. 80). This device, together with the 
legal invention of limited liability and the work of the Stock 
Exchanges, enables the organization to collect annually from the 
public an immense number of small portions of capital, to add 
together innumerable short lengths and small quantities, and to 
place vast supplies at the disposal of States, Municipalities and 
business enterprises of all descriptions at home and abroad. M. 
Neymarck's ^^ figures for the aggregate annual issues of the twenty- 
nine principal markets of the world show the volume of capital 
annually obtained by this means and the nature of the bodies to 
whom it was supphed. 

Annual Issues (World) £ m. 

1904 . . . . 576 

1905 764 

1906 . . . . . . . . . . 1060 

1907 .. .. .. .. .. 612 

1908 848 

Total (five years), ;^386o m. Annual Average, ^772 m. 

Issues 1907 and 1908 (World) 

1907. 1908. 

Per cent. Per cent. 

Loans of States, Provinces, and Towns 35' 89 34* 17 

Establishments of Credit . . . . 993 6*47 

Railways and Industrials . . . . 52*72 57' 80 

Conversions . . . . . . . , 1*46 1*56 

This method of expressing demand in the form of negotiable 
securities gives the market peculiar facihties for supplying capital 
to foreign countries ; for, with the growth of knowledge and con- 
fidence, the bonds of an American railway or of a European State 
can be sold in London almost as readily as home securities of a 
corresponding character. It is truQ that neither the (xerman 
market nor, until recent years, the United States market, has 
done much work in financing foreign countries ; but this is because 
their capital has been needed mainly for home development. The 
French and English markets, however, give ample evidence of the 
effect of the invention of the negotiable security in promoting the 
international mobility of capital. It is estimated that in 1908^ 
the total of French Valeurs Mobilidres was very nearly £3000 m., 
of which some 10 per cent was held by foreigners ; while French 
holdings of foreign securities amounted to about one-half of this 
figure. By means of the Valeur Mobiliere, therefore, France had 
borrowed from abroad to the extent of some £300 m. and had 
lent to foreign countries no less than £1500 m. The Enghsh, or 


what is practically the same thing for this purpose, the London 
market is even more important as a source from which foreign 
countries draw their supplies of capital. In 1909 Sir George Paish 
made an estimate of the total foreign investments of the United 
Kingdom in 1907-8 ; this estimate is given in a compressed 
form below :-^ 

Government Loans and Municipal Stocks . . . . 757 

Railways.. .. .. .. .. .. .. 1199 

Banks and Finance Companies . . . . . . 241 

Canal, Docks, Electric Light and Power, Gas, Tele- 
graphs and Telephones, Tramways, Waterworks 106 
Mines . . . . . . . . . . . . . . 243 

Breweries and Distilleries, Nitrate, Oil, Rubber, Tea, 

and Coffee . . . . . . . . . . . . 69 

Commercial and Industrial, etc. . . . . . . 78 

^^2693 m.« 

It is not worth while to make any statistical comparison between 
the volume of capital supplied through the market for negotiable 
securities and the amount supplied through the banks and mortgage 
agencies, or between the volume of capital supplied to foreign 
countries by this market and that supplied by other parts of the 
market machinery. It is sufficiently evident from the figures 
already quoted and from common knowledge that the negotiable 
securities market is the most powerful single agency for collecting 
capital, and that it is much the most effective part of the market for 
dealing with the supply of capital to foreign countries. 

There is, however, one further point of general interest : namely, 
the question of the comparative efficiency of the negotiable security 
as a means of supplying capital to different classes of borrowers. 
Is it as effective in drawing capital into ordinary business under- 
takings as into the hands of such public or semi-public bodies as 
States, municipalities and railways ? This question of the suit- 
ability of the negotiable security as a means of meeting the home 
industrial demand for capital must be discussed in connexion with 
the machinery of the market (Chapter XXXIII, esp. pp. 218-9) ; at 
the moment it is sufi&cient to n,otice that more than two-thirds of 
our foreign investments consist of the securities of public bodies 
and railways. 

The invention of the negotiable security and the rapid develop- 
ment of its markets during the nineteenth century have produced 
effects comparable in importance and similar in kind to those 
arising from the corresponding growth of railways and steamships. 
The development of more efficient means of transport has immensely 
increased the mobility of goods and consequently extended the 


range within which they can be marketed. By so doing it has 
made it more easy for individual factories and industries to settle 
in the districts of greatest natural advantage, thereby giving scope 
for increased specialization, international and national, and a great 
expansion in the scale of production of the individual factory or 
industry. The negotiable security has produced similar effects. 
It has increased the mobility of capital directly by making possible 
the collection into large aggregates of many thousands of small 
quantities of capital individually ineffective ; and it has increased 
it indirectly by providing stock and share holders with a security 
which can be very readily charged in support of demands for loans 
from a banker or other party. In these two ways it has led to 
increased specialization in the functions of supplying capital and 
employing it ; for, on the one hand, it has enabled the capitalist, 
who has no ability or inclination for management, to make a 
profitable investment of his resources, thereby increasing the 
quantity of capital coming forward ; and, on the other hand, it 
has enabled business men without resources to obtain the capital 
they require, thereby increasing the quantity of managing ability 
available for production. In other words, it has enabled the com- 
munity to specialize in the separate production of capital and 
business ability. 

The effects of the market in increasing the available supply 
of business men and in enabling immense quantities of capital 
to be concentrated under a single control has naturally emphasized 
the influence of the general tendencies leading to large scale under- 
takings and enormously increased productivity. The full social 
effects of the negotiable security have yet to be disclosed. It is 
clear that its invention has greatly increased the financial power of 
the State and that, in conjunction with the joint-stock company 
form of organization, it has made possible the construction of 
immense productive works, the growth of powerful financial institu- 
tions, such as banks and Insurance companies, whose efi&ciency 
depends largely on their size and the imdertaking of risky develop- 
mental work throughout the world. By means of the holding 
company and similar forms of organization it has often placed 
immense powers in" the hands of business men, enabling them to 
obtain a partial monopoly in important branches of home pro- 
duction, to exercise concealed but extensive control over the 
industries of other countries,^^ and by further combination to 
extend their influence so far as to obtain a predominating influence 
over the world's supplies of important commodities. And yet, in 
opposition to its effects in facilitating concentration of control, 
the negotiable (security is simultaneously facilitating a wide diffu- 
sion of the ownership of property. The ownership of State and 


municipal debts, railways and a vast number of undertakings of all 
descriptions, of a total value in 1908 of some £20,000 m.^^, is dis- 
tributed in small portions among a multitude of holders throughout 
the world. The effects of this diffused ownership in consolidating 
the interests of nations and of individuals within each nation, and 
of lessening the social consequences of monopolistic control, have 
yet to be clearly seen. 




WITH this brief review of the constitution and general 
features of the market, we now turn to consider more 
closely the nature of its work, the standard by which 
its efficiency is to be judged and the conditions on 
which that ef&ciency depends. 

The discussion dealing with the banks and with Trade Credit 
is complicated by the fact that the operations of those parts of 
the market include not only the transport of capital but also the 
creation of purchasing power. That compUcation does not now 
arise. The market for new negotiable securities is as simple in its 
essential function as the railway which carries goods from points 
of plenty to points of most urgent demand. It lies between the 
group of capitalists in possession of available resources and the 
group of entrepreneurs and other parties in need of these resources ; 
its function is to carry capital — or, rather. Command over Capital — 
from one group to the other ; and the standard by which its work 
is to be judged is that of its ef&ciency in facilitating the movement 
of capital to the points of highest net yield. 

This manner of expressing the standard in which the efficiency 
of a market agency may be judged is convenient enough in deal- 
ing with agencies whose work lies mainly on the side of Supply. 
But we need now to translate this standard into terms appropriate 
to a different point of view ; for the work of this market lies mainly 
on the side of Demand (cf. pp. 103, 122). It is its business to formu- 
late the social need for capital into an effective market demand, and 
by so doing to facilitate the flow of capital to the points of highest 
net yield. What are the essential conditions which must be satisfied 
if this ideal is to be attained ? 

The sources of demand for capital are of course very varied 
and numerous ; they may be represented by promises issued by a 
State, a municipality, a railway or an ordinary business enterprise ; 
or they may be represented by a share in the earnings of some 
undertaking ; but whether they take the form of a promise to pay 

or of a share in profits, they represent prospective yield. It is the 



business of the market to select the sources of highest yield, to 
capitalize these in the form of stocks and shares and to sell these 
securities to the public. If this operation is to be carried out in 
accordance with the social interest, if it is to facilitate the movement 
of capital to the points of highest yield, it is clear that, subject to 
minor qualifications, two main conditions must be satisfied. In 
the first place, the source of earning power must be rightly formu- 
lated in order that it may exert its appropriate attractive power 
upon the available supply of capital ; in more practical language, 
the property must be sold to the public at a price corresponding as 
nearly as possible to the capitalized value of its prospective net 
yield ; it must be sold at its Investment Value (cf. p. 226). In 
the second place, the work of marketing securities must be carried 
out as economically as possible. These are the two main criteria 
by which the efficiency of this market may be judged. 

Before passing on to consider how far in fact the marketing 
of securities is carried out in conformity with the social interest, 
we may touch in a preliminary way on the tendencies to diverge 
from this ideal which arise from peculiarities in the nature of the 
market, and on the methods by which these tendencies are checked. 
From a consideration of these peculiarities may be drawn certain 
general inferences whose truth can subsequently be tested by 
reference to actual marketing operations. 

It can hardly be doubted that the dominating characteristic 
of the markets for negotiable securities — that which colours most 
of their incidents — ^lies in the fact that the value of the security, 
the commodity in which they deal, depends upon a set of present 
and future circumstances so complex that an accurate estimate 
can be made only in the light of expert knowledge. If, as in the 
wholesale markets for sugar or coffee,^^ buyers and sellers were 
usually equally expert, this peculiarity would perhaps have no 
great significance ; but in fact this is not so, for those whose business 
it is to sell securities are often in direct contact with an unskilled 
investing and speculating public. Sellers have a more intimate 
knowledge of the commodity in which they deal than buyers, 
and this superior bargaining knowledge gives wide scope for de- 
ception. In the market for new securities this condition enables 
the company promoter to sell worthless securities to the public ; 
in that for old securities, the Stock Exchange, it enables the specu- 
lator with inside knowledge to draw abnormal profits by dealing 
with investors less well informed than himself. 

Further, it may be repeated that while the profits of a bank 
or a Trust company are directly dependent upon the wise applica- 
tion of the public capital which they control, the profits of the 
intermediaries in the securities market depend upon the difference 


between the price at which they buy from the vendors and the 
price at which they sell to the public ; broadly speaking, their 
self-interest is bound up with the real earning power of the property 
they sell only in so far as they have a reputation to lose, only in so 
far as their reputation and therefore their power to make future 
profits is dependent on their honest dealing. 

Finally, the opportunities for profitable deception are increased 
by the nature of the public, by the fact that advertisement, sug- 
gestion and more dubious methods may be effectively employed 
to excite the speculative tendencies of the investor and to en- 
courage optimistic estimates which enable securities to be sold at 
prices far above the value of the property they represent. These 
conditions give little assurance that capital will flow into its most 
profitable uses ; on the contrary, they inevitably give rise to strong 
tendencies for capital to flow into the pockets of promoters or to be 
dissipated in the heavy expenses necessary for effective deception. 

This view of the market is, however, far too gloomy ; for not 
only are the opportunities for deception limited by the nature of 
the securities sold, but they are also limited by devices of organiza- 
tion and of the law. 

When a new issue consists of the stocks of a reputable State 
or the well-secured bonds of a sound American railway, public 
knowledge of the reputation of the borrower, or of the prospects 
of the undertaking, may be sufficient to yield a fair estimate of 
their true value ; bargaining knowledge is fairly equal, and the 
marketing agency cannot obtain excessive profits at the expense 
of the public. It happens, too, that the natural safeguard accom- 
panying the sale of these securities is supplemented by a further 
safeguard arising from the circumstance that their sale is frequently 
effected by first-class firms whose reputation and profit are de- 
pendent on fair dealings. In the multitude of securities of more 
dubious value where the safeguard of public knowledge does not 
exist, the protection of such middlemen is in general also lack- 
ing, so that the principal limitation to deception lies in the 
advisory organization of the market — the investment broker and 
the financial press^and in the legal enactments devised to secure 
the publication of essential particulars necessary to form a sound 
judgment of the securities in question. 

These considerations with regard to the general character- 
istics of the market lead then to the following provisional con- 
clusions : that owing to the very great complexity of the causes 
determining the value of the new security, it is very difficult and 
often impossible for any accurate estimate of its value to be formed 
by the public ; that in the sale of high-class securities the differ- 
ence of bargaining knowledge between buyer and seller is much 


less marked and the public are sometimes further protected by the 
high reputation of the middlemen ; but that in the more obscure 
kinds of securities the scope for deception is large, the tendency 
to deception little restricted by the organization of the market and 
the limitation of deception consequently dependent mainly upon 
the provisions of the law and the growth among the speculating 
and investing public of a firmer recognition of the realities of the 



IT was suggested in the previous chapter that the efficiency of 
the market differed widely in dealing, on the one hand, with 
securities whose earning power could be estimated reasonably 
well by the public, and, on the other hand, with more obscure 
securities whose earning capacity was either unproved or unknown 
to the investor. There is no natural line of cleavage dividing 
securities into these two classes ; they form a continuous series 
ranging from the stocks of a first -class State to the shares of a small 
company formed, perhaps, to exploit the doubtful possibilities of an 
invention or an undeveloped property abroad. Modes of thought 
and language are still inadequate to enable us to deal with such a 
series as a whole. Yet the distinction between securities of which 
the buyer has knowledge and securities of which he has substan- 
tially none is evidently one of great importance in considering 
whether the conditions of sale carry with them a reasonable likeli- 
hood of advantage to both parties. An attempt must be made, 
therefore, to separate the two, even though the line of division is 
necessarily of an arbitrary character. 

But at this point arises the difficulty that the knowledge and 
judgment of investors vary as widely as the character of securities 
offered, that it would be absurd to postulate an investor whose 
bargaining knowledge might be regarded as representative. There 
is no need for concern as to the welfare of Insurance, Trust and 
Finance companies, the banks and other experts ; they are not likely 
to suffer from imperfect bargaining knowledge. The parties of 
whose interests we need to take account are the outside pubhc ; and 
the investor of whom we speak must be conceived to be that part of 
the investing and speculating public who do in fact compose the 
market for the particular kind of security of which at the time we 
are speaking. 

It seems reasonable to assume that the investor has fairly ade- 
quate bargaining knowledge when he enters the market to buy, 
let us say, the stocks issued by a Colonial Government, a reput- 
able foreign State or a large municipality, or the debentures or 



preference shares offered by a railway of proved earning capacity 
For the purpose of the very general argument which follows it is 
not necessary to particularize further. Let us make an exceedingly 
rough division of the whole series of securities offered in the English 
market, placing on the one side stocks and shares of the kind just 
described, and on the other a large mass of less well-known securities 
whose main constituents are the stocks and shares of new joint-stock 
companies, formed under the Companies Acts ; and let us consider 
broadly how far the conditions of sale of these two groups of secur- 
ities offer a reasonable protection to the public — ^how far they facili- 
tate the flow of capital into its most profitable uses. 

The following table shows the average amounts of the new 
securities of various kinds o:ffered in the London market during the 
three years 1911-13 inclusive. 

Average Annual Issues on the London Market for the Three 
Years 1911-13 inclusive (extracted from The Economist) 


British, Colonial and Foreign Government loans . . 37,243 

British Municipal loans . . . . . . . . 1,262 

Colonial and Foreign Corporations . . . . . . 16,164 

British railways . . . . . . . . . . . . 1,983 

Indian, Colonial and Foreign railways . . . . 55,286 


Mining Companies . . . . . . . . . . 5,494 

Exploration and Financial . . . . . . . . 9,164 

Estate and Land . . . . . . . . . . 6,681 

Electric Lighting, Power, etc. . . . . . . . . 7,507 

Tramways and Omnibuses . . . . . . . . 8,610 

Banks and Insurance . . . . . . . . . . 5,653 

Manufacturing . . . . . . . . . . . . 9,587 

Rubber and Oil 7,315 

Iron, Coal and Steel 6,292 

Miscellaneous 21,474 

Destination of Capital 


United Kingdom 35. 811 

British Possessions . . . . . . . . . . 71,258 

Foreign Countries . . . . . . . . . . 92,646 


It is not possible to say what proportion of this aggregate amount 
was subscribed by English investors ; but it is evident that the 
demand for capital is represented mainly by issues of the kind fall- 
ing within the group of sound securities with which we are now 


The public may have little direct detailed knowledge of the 
revenues or earning capacities on which these securities are based ; 
but the reputation of the responsible parties enables them to form a 
fair estimate of the value of the securities offered, and it seems fair 
to assume, as has already been done, that their bargaining know- 
ledge is reasonably adequate to protect their interests. Moreover, 
a moderate proportion of these securities are sold to the public 
through the intermediation of Issuing Houses of high financial 
standing, who have expert knowledge of the value of the securities 
which they purchase from the vendors and a direct business interest 
in maintaining their own reputation by refraining from selling to the 
public securities whose future yield is very precarious. These con- 
ditions strongly suggest that the opportunities and tendencies for 
any unfair dealings in this part of the market are negligible. 

As implied in the preceding paragraph, the securities with which 
we are now dealing may be sold in either of two ways : the responsi- 
bility for the marketing operation may be undertaken by one of the 
great Issuing Houses, who buy from the vendors and resell to the 
public ; or the risks of the operation may be borne by the vendors 
themselves acting through financial agents in London. 

During the three years 1912-14 the leading London Issuing 
Houses undertook the sale of a large volume of securities : these 
issues included the stocks of foreign Governments such as China, 
Mexico and Brazil ; those of the cities of New York and Bergen ; 
those of Mexican and Brazilian railways, foreign telegraph and trans- 
port companies and a few large home industrials such as the de- 
bentures of the London General Omnibus Company. The volume of 
their sales is large, but it forms only a comparatively small pro- 
portion, considerably less than one-half of the total amount of high- 
class securities sold on the London market. The character of their 
work is indicated by the nature of the securities described ; they deal 
only in the best qualities, and limit their operations almost entirely 
to the marketing of foreign, as distinct from home, securities. 

The high reputation of these houses ensures that their interests 
are in a great measure identical with those of the investing public ; 
but it clearly cannot, of itself, show that the margin between the 
price at which they buy and the price at which they sell to the 
public is such as to yield them only a fair payment for work done. 
It is very difficult to get any exact information as to the margin of 
profit which they obtain. One or two houses, it would seem, have 
substantially a monopoly in marketing the securities of certain 
foreign States ; but in general it appears to be the fact that the price 
of purchase from the foreign vendor is settled by informal negotia- 
tions which amount, in effect, to competitive tender. A part of the 
margin between the purchase and sale prices goes, of course, to the 


underwriters, for practically all these issues are underwritten ; while 
the payment going to the Issuing House seems to be determined, 
as one would expect, largely on a customary basis with special 
allowances for exceptional conditions. These considerations do not 
carry one very far ; but they suggest that, in so far as the margin 
is determined on the one hand by the opinion of a well-informed 
public, and on the other by bargaining which amounts in effect to 
competitive tender, the English Issuing Houses are not likely on the 
whole to obtain from the public much more than a reasonable 
payment for their costs of investigation, their special knowledge of 
the market and the services of their business reputation and con- 
nections. And this conclusion is supported by the opinion of 
business men with knowledge of the actual facts of the situation. 

More definite information is available with regard to the con- 
ditions of sale of the large remainder of high-class securities which 
are sold by the vendors through London agents ; for it seems reason- 
able to regard as fairly typical of these conditions the methods 
of marketing Colonial and Indian loans recently investigated and 
described by Dr. Theodor Schilling. ^^ 

In the negotiation of these loans there are, it appears, four prin- 
cipal parties. Each government has, in the first place, a London 
representative by whom its general business is carried through ; 
he may be an Agent-General, a High Commissioner, the Crown 
Agents for the Colonies or the Secretary of State for India. It has 
also a financial representative : for the Crown Colonies there are the 
Crown Agents ; for New Zealand, Queensland and the Transvaal 
there is the Bank of England ; for Canada and most of its provinces 
and towns, the Bank of Montreal ; for South Australia, the Bank of 
Adelaide ; and for the remaining Australian States, the London 
County Westminster and Parr's Bank. The banker, it seems, acts 
purely as an agent ; he advises the London representative with 
regard to the market conditions and the price and date of the issue, 
and undertakes such work as the announcement of the issue, the 
receiving of subscriptions and the payment of dividends. 

In addition to these representatives each government has its 
own broker, who is usually one of three large firms : Nivison & Co., 
who act for most of the self-governing colonies ; Scrimgeour & Co., 
who deal mainly with the business of the Crown Colonies ; and 
Mullens, Marshall & Co., who, as brokers of the Bank of England, 
take part in issues for which the Bank is the financial agent. Among 
other duties the broker advises the London representative prior to 
the issue and, after its terms have been settled, undertakes to place 
the underwriting. It would, perhaps, be more exact to say that he 
allots the underwriting, for it seems probable that the parties with 
whom he places it would usually accept their quota even though 


such a commitment happened at the moment to be particularly un- 
welcome. Finally, there are the Jobbers who, according to Dr. 
Schilling, play an important part in the work of issue, partly by 
undertaking a share of the underwriting, but mainly by their in- 
fluence on the Stock Exchange quotations of the new security. 
Prior to its issue, it would seem, they encourage public subscription 
by " making a market " at prices which are in a great measure 
artificial (a practice prohibited during the war), while subsequent 
to allotment they agree with the brokers whether the securities 
should be quoted at a premium or a discount. 

This brief indication of the functions of the various parties 
concerned in the sale of these securities makes it unnecessary to 
trace the procedure in detail. It may be noticed, however, that the 
method of issue has changed. The earlier practice of inviting 
subscriptions by way of public tender has now been abandoned ; 
with rare exceptions the modem practice is to issue the loan at a 
fixed price, the risks of failure being covered by underwriting. 

A more important question is that of the rates at which these 
various parties are paid for their services. Business tradition 
and feeling assign the whole of the loan operations of each govern- 
ment to its recognized banker ; and the same conditions presumably 
govern its relations with its broker. It is hardly possible, therefore, 
for direct competition to play any important part in regulating 
marketing costs ; the question whether or no those costs are ex- 
cessive must be judged by other means. According to Dr. Schilling, 
the issuing bank receives J per cent to i percent ; the customary 
rate for underwriting (a rate rarely exceeded) is i per cent ; while 
J per cent is paid to the broker for placing the underwriting and a 
further J per cent on applications bearing a broker's stamp. In 
addition to these payments there is a stamp duty of 2s. 6d. to 12s. 6d. 
per cent, together with the expenses of printing the prospectus and 
securities, and giving public notice of the issue. As to the expenses 
incurred by the London representative, and the special fee, if any, 
paid to the broker, Dr. Schilling gives no information ; but it seems 
hardly likely that such costs would form any considerable addition 
to the total. Only expert knowledge can decide whether or no 
these rates form a reasonable payment for work done ; but their 
total amount is not large, and is clearly much lower than the fraction 
which is usually absorbed by the market in effecting the sale of 
industrial stocks and other securities of a lower order of reputation. 
The general impression which one derives from these facts is 
borne out by a consideration of the conditions in which State and 
Communal loans are issued in Germany. Dr. Riesser (1908) main- 
tains that a vast amount of labour and sagacity is now necessary in 
order to earn a profit in the marketing of stocks of this kind. 


The sale of these securities appears to be effected almost 
entirely by syndicates of banking houses : there are, for example, 
a Prussian syndicate for issuing Prussian State loans, composed 
of the Seehandlung and about twenty-eight other houses ; a group 
for dealing in Imperial loans, headed by the Reichsbank and includ- 
ing some twenty-eight other firms ; and other permanent groups 
formed to issue home State and municipal loans. These syndicates 
carry out their operations through managers who are responsible 
to an executive committee representative of the group. The first 
stage of the operation naturally consists of an inquiry into the value 
of the securities to be sold, to which may be added the settlement 
of detailed arrangements with regard to the provision of funds for 
the payment of dividends, the publication of notices and other 
minor matters. In determining the price at which the syndicate 
shall purchase from the vendors, and the price and date at which 
they shall issue to the public, an intimate knowledge of the market 
is necessary, for a wrong estimate of the potential demand, or an 
unforeseen change in the conditions of the market, may result in 
the bulk of the securities remaining unsold in the hands of the 
members of the syndicate. " The lower limit in this case, too, is 
the price to the underwriter, plus interest, stamps, fees and a profit, 
which, if possible at all, varies in the case of domestic and communal 
loans between J, J and, in rare cases, J of i per cent, while in the 
case of foreign state loans a profit of | of i per cent is a rarity." ®^ 

The work of the syndicate does not end with the completion of 
the sale operation, for banking practice and etiquette extend its 
responsibility to the protection of the securities against unjustified 
fluctuations in their value. One method of checking fluctuations is 
to eliminate the " stag " by offering preferential terms to those 
subscribers who will deposit the securities they purchase with the 
issuing firm, undertaking not to sell them within a given period 
of some months after the issue. A more common method, however, 
is for the syndicate to protect the value of the securities by re-pur- 
chase in the market when prices fall in consequence of temporary 
causes which are unlikely to exert a permanent effect on their 
investment value. Some of the German syndicates appear to 
possess a monopoly of the issues in which they deal ; but it is clear 
that their operations involve a great deal of work and considerable 
risks ; and there seems to be no reason to suppose that the profits 
which they derive from this work are unduly large ; indeed, a director 
of the Dresdner bank maintains that for years the marketing of 
German state loans has been generally a source of loss to the issuing 
banks. ^1 

The well-nigh impenetrable obscurity in which high finance 
chooses to conduct its work makes it very hazardous to attempt 


to reach definite conclusions on the limited information which is 
available. It seems tolerably certain that Colonial and Indian 
securities are sold to the public at a fair price and at a moderate 
cost, and probable that the same thing is true of the securities 
marketed through the great Issuing Houses. Further, there seems 
every reason to suppose that English State and municipal securities, 
and, with one or two exceptions, home railway stocks also, are 
marketed honestly and tolerably cheaply. 

These considerations do not justify the statement that the 
parties undertaking this marketing work never receive more than a 
fair payment for their services. They do, however, bear out the 
a priori assurance that there is little scope for abuse in the marketing 
of highly reputable stocks ; and suggest the conclusion that the 
sale of these securities on the London market is carried out with 
reasonable efficiency and economy. 



IN the previous chapter we dealt with the sale of high-class 
securities mainly from the point of view of the English 
investor, making no distinction between the parties, English 
or foreign, to whom capital was supplied. In this chapter 
we have to deal with the sale of a second group of securities con- 
sisting mainly of the stocks and shares of an immense variety of 
joint-stock companies operating at home and abroad. In con- 
sidering the marketing of these securities we must adhere more 
closely to the main question with which this book is concerned, 
and endeavour to estimate the work done by the market in supply- 
ing capital to English undertakings. The principal questions, 
therefore, which we have to face are those of the scope and efficiency 
of the market in facilitating the sale of English industrial securities ; 
we require to know the extent to which this particular market 
provides the capital which English business men require and 
the efficiency with which that capital is actually supplied. To 
answer these questions satisfactorily would require intimate 
knowledge of the marketing organization not only in London 
but throughout the Provinces, and would involve a discussion of 
very great length ; for the published information is quite in- 
adequate, and the great variety in the character of the securities 
marketed makes the matter one of exceptional complexity. It 
is as well, therefore, to state at once that the broad treatment of 
the subject, which is all that is attempted in these three chapters, 
can yield little more than general impressions open to considerable 
possibilities of error. 

In approaching the first question with which we have to 
deal — that of the amount of capital annually supplied by 
this market to English undertakings — we are at once met by 
the difficulty that the available statistical information is ex- 
ceedingly meagre. As, however, it is almost useless to discuss 
the work of the market with no knowledge of its scope, we 
must review the available information and endeavour to infer 
some conclusion. 


We have, in the first place, The Economist's figures quoted on 
page 194, which show that the average annual applications 
(1911-13) for capital destined for home employment amounted 
to some £36 m. Deducting British Government loans, municipal 
stocks and English railway securities, we obtain a total of some 
£33 m. for what may be broadly described as home industrials. 
This figure is carefully compiled; it includes offers made only 
to shareholders, and excludes issues made by way of tender or 
for payment of maturing loans. It is perhaps the best obtain- 
able ; but it omits many industrials floated in the Provinces, 
and is made up of capital applications, not of capital actually 

The annual reports on companies issued by the Board of Trade 
add a little, but not much, to this information. They show that 
each year some 6500 new joint -stock undertakings are registered 
under the Companies Acts in England and Wales (as distinct 
from the United Kingdom) ; that there is a net annual addition 
to the register of some 3400 companies and £97 m. paid-up capital ; 
and that in April 19 14 the total number of these companies 
amounted to 58,000, with a paid-up capital of nearly £2300 m. 
To this figure must be added an estimated amount of £500 m. 
obtained from the sale of debentures,*^ making the total capital 
which they control about £2800 m. It may not, however, be 
assumed that any large fraction of this total capital was supplied 
by means of the machinery of the market ; how small that 
fraction actually is may be inferred from the fact that in 1904, 
of 3477 new companies registered in London no less than 3068 
filed a declaration that they were making no appeal to the pubUc.** 
The explanation lies in the fact that the most common form of 
limited liability organization is not the Public, but the Private, 
joint-stock company. During the three years ending December 
1913 an average number of 5400 Private companies was regis- 
tered ; in December 1914 their total number was almost exactly 
three-quarters of the whole. It does not, of course, follow that 
these companies control three-quarters of the aggregate capital, 
for their average size is probably small. But they include large 
and important firms, such as Harland & Wolff and Huntley & 
Palmers, and control an important part of the business of the 

The legal form of the Private company was invented, or per- 
fected, by the Companies Act of 1908. By this enactment the 
Private company was denied a public market in its shares (though 
not in its debentures) : it could make no public offer of its shares, 
and was required to restrict their transferability and to limit 
the number of its shareholders ; but it was granted the advantages 


of limited liability and joint-stock organization and excused the 
duty of publishing a prospectus, a statement in lieu, or an annual 
balance sheet. The very rapid growth of this form of organiza- 
tion, due not only to the creation of new undertakings, but also 
to the conversion on a large scale both of public joint-stock com- 
panies and private firms, is significant, therefore, in showing 
that the facilities of a public market are by no means the all- 
important consideration in the development of the joint -stock 
type of organization. 84 However, the point of importance at 
the moment lies in the fact that the vast majority of the 
joint-stock companies coming into being each year are either 
already in possession of their capital or obtain it by way of 
private negotiation. 

In attempting to form any estimate of the amount of capital 
annually supplied to these undertakings by the agency of the 
market we have then to take account mainly of public companies ; 
but even in this limited field the imperfection of the statistics 
makes any definite conclusion difficult if not impossible. The 
following statement shows the average number of new companies 
of various kinds annually registered in England and Wales during 
the three years 1911-13 : 

1. Companies of a kind which may be omitted from considera- 

tion, e.g. companies limited by guarantee . . . . 145 

2. Private companies , . . . . . . . , . . . 5423 

3. Public companies formed with a prospectus . . . . 378 

4. Public companies formed without a prospectus . . . . 596 


It is with the two kinds of Public companies included under 
3 and 4 that we are now primarily concerned. In neither case is 
information given of the amount of capital annually subscribed 
by the public. 

The returns distinguish, however, in respect of each of the 
companies in the former group, the " Amount offered for Sub- 
scription in Cash " ; and these individual amounts added together 
yield an annual average of £17 m. But this £17 m. represents 
the demand for capital. A figure more representative of supply 
is found by summing the individual items given under the heading, 
" Amount allotted before commencing Business." The corre- 
sponding annual average of these amounts is £9^ m. This figure 
needs careful interpretation. It represents, very nearly, the face 
value of the shares actually bought by the public ; it relates 
mainly but not wholly to capital destined for employment at 
home ; it includes the full amount which may be called up 


on the shares actually sold ; but it does not include capital 
which may be raised later by the public or private sale of 
further shares or by the issue of debentures. It forms a rough 
estimate of the amount of capital annually subscribed by the 
public to this group of companies on their formation. From 
the fact that only 165 of these 378 companies applied for a 
special settlement on the London Stock Exchange, it may 
perhaps be inferred that more than one-half were floated in the 

That estimate of capital subscribed is sufficiently rough, but 
it is more definite than the conclusion to be drawn from a con- 
sideration of the companies which " file a Statement in lieu of a 
Prospectus." The returns show in respect of each of these com- 
panies " the Amount Subscribed or which may be Subscribed in 
Cash " ; and the sum of these individual amounts yields an annual 
average of £33 m. How much of this demand for capital was 
actually satisfied it is quite impossible to say. In the absence 
of any statistics, it seems not unreasonable to reduce the 
figure in the same proportion as that of the former group 
of companies, and reckon the capital actually supplied to be 
about £18 m. 

Although a small proportion of these companies paid an under- 
writing commission, and a few may have marketed their shares 
through intermediary organizations in the form of an Offer of 
Sale, it seems clear that no considerable part of their capital could 
have been obtained by the normal method of public issue. The 
greater part of it must have been obtained mainly by private 
negotiation in the manner employed by Private companies and 
by cotton-spinning undertakings in East Lancashire, or by a gradual 
unloading of shares on the Stock Exchange. The former method 
would naturally be employed in many cases where a new under- 
taking, or an old firm converted into company form, offered prospects 
of success too good to be shared with the general public. If the 
amount of new capital it required were moderate, its securities 
could be readily placed among parties connected by personal or 
trade interests. Mr. Duguid, writing of the latter method of selling 
securities, says : " The shares of many excellent companies have 
been introduced in that way. Few, if any, of all the great Rand 
mining companies, with the huge dividends they have paid since, 
issued a prospectus. It was a case of ' making a market ' in nearly 
every instance." ^5 

That this latter method is adopted on a considerable scale is 
suggested by the fact that more than a hundred of these companies 
annually applied for a special settlement on the London Stock 


We have then these three totals : 

Annual Averages for the Three Years 1911-13 
Capital applications for " home industrials '* vide The 

Economist . . . . . . . . . . . . . . £33 m. 

Capital subscribed by the public to new joint -stock com- 
panies formed in England and Wales, under the 
Companies Acts, with a prospectus, say . . . . 9^ m. 

Capital subscribed by the public to new joint -stock com- 
panies formed in England and Wales under the Com- 
panies Acts, without a prospectus, say . . . . 18 m. 

Provisional total . , . . £60 m. 

This aggregate of £60 m. is less than one would expect ; even so, 
substantial deductions must be made from it in order to obtain 
any estimate of the volume of capital annually supplied to home 
industrials by the market for new Stock Exchange securities. 

(i) The first total consists, as already noticed, of applications 
for capital and not of capital actually subscribed ; further, it relates 
to the United Kingdom, not only to England and Wales. A rough 
correction for these errors may be made by reducing its amount 
from £33 m. to £30 m. 

(2) A substantial part of the second total is included in the 
first ; for although a large proportion of these companies may be 
floated in the Provinces, those in need of large amounts of capital 
naturally make their applications mainly through the London 
market, and so are already included in The Economist's figures. 
When allowance is made for this and for the further consideration 
that, so far as may be judged by their titles, about one-quarter of 
these companies employ their capital abroad, this second total can 
hardly be reckoned at more than £4 m. 

(3) The bulk of the third total is apparently obtained by the 
sale of shares by private negotiation and by unloading them on 
the Stock Exchanges. A small part is obtained by public issue in 
the form of Offers for Sale through intermediary organizations 
on the London market, and so is already included in the figures of 
The Economist. As a rather larger proportion of these companies 
appear to employ their capital abroad, the already conjectural 
total of £18 m. should perhaps be reduced to £12 m. 

(4) It is probable that some part at least of the unsold shares 
of these two groups of companies are later unloaded on the Stock 
Exchanges or placed by private negotiation. As it is quite impossible 
to guess at the amount of capital which the companies may obtain 
in this way, it must be hoped that the margins of the other estimates 
are large enough to make this omission of inconsiderable import- 


ance. Some addition must, however, be made for the Provincial 
sales both of debentures and of the securities of those Gas, Elec- 
tricity, Water and Tramway undertakings which have not been 
formed under the Companies Acts and consequently have not yet 
been accounted for. But, as The Economist's figures include a 
large amount of debentures sold on the London market, and as the 
total annual increase in the capital of Gas and Tramway under- 
takings of all kinds amounted, in pre-war days, to only about 
£5 m.,** the allowance to be made under this head can hardly 
be a large one. 

On the whole, it seems tolerably safe to conclude that, when 
these various corrections have been made, the aggregate figure 
does not exceed £55 m. per annum. 

(5) It is important to notice that this figure represents at best 
only the amount of capital subscribed by the public ; it does not 
represent the amount of capital passing through the market into 
real investment. Some of it is a mere transfer to vendors in ex- 
change for property sold to the company, some of it is applied to 
pay off debts, some of it is absorbed by the promoter and other 
market agencies. Although the recipients of these sums may 
apply them to investment purposes, to reckon them in the present 
estimate would result in considerable duplication. The available 
information is quite inadequate to show what allowance should 
be made for this difference between the amount of capital sub- 
scribed and the amount applied to the extension of home under- 
takings ; moreover, the difference is likely to vary considerably 
from year to year, with changes in the number of conversions of 
existing undertakings into the form of Public companies. An ex- 
amination of the individual home issues in The Times Prospectuses w 
for 1913 suggests that in that year about one-sixth of the capital 
subscribed represented a transfer, rather than an investment, of 
capital. This proportion seems likely to be too low rather than 
too high. If we employ it to make the final correction we may 
conclude that in the three years 1911-13 (a period of active 
business) the average amount of capital collected by the market 
from the public and applied to the extension of home under- 
takings in England and Wales was in the neighbourhood of £45 m. 
per annum. 

This figure, being based on conjectural estimates, is open to 
considerable possibilities of error ; but precision is not required ; 
its significance lies in its relation to more general considerations. 
It was commonly held in the City prior to the war that the annual 
savings of the United Kingdom were then about £400 m., and 
were devoted half to foreign, half to home investment. This figure 
is probably rather too great ; but it seems tolerably certain that 


in 1907 the total addition to the capital invested in the United 
Kingdom was between £200 m. and £230 m.^ When this figure 
is brought into relation with the facts and inferences of this chapter 
(see also Chapter XLIV), the contrast conveys a clear impression 
that the market for new Stock Exchange securities plays a smaller 
part than one would suppose in facilitating the movement of the 
annual flow of free resources into home investment. 


THE subject of discussion in this chapter is still the 
marketing of the second group of securities, consisting 
of industrials and other stocks and shares of a quality 
inferior to gilt-edged securities. But we are now concerned 
not with the scope of the market's work but with its ef&ciency. 
We have to consider, first, whether the general conditions govern- 
ing the sale of these securities are such as to ensure fair bargaining 
between buyer and seller ; and, secondly, whether the actual sale 
operations are reasonably effective and economical. 

We approach the first of these two questions, bearing in mind 
the two general inferences reached in the preceding chapters : the 
one that the great difficulty of estimating the value of securities 
places sellers in a position of superior bargaining knowledge and 
so gives them considerable opportunities for deception ; the other, 
that this condition is reinforced by the susceptibility to suggestion 
of the parties who buy these securities — a susceptibility which leads 
them, when some particular market is booming, to buy the securities 
in which it deals with little or no discrimination between those 
which are sound and those which are almost entirely worthless. 
But the imperfection of knowledge on the part of the investor, 
which is the basis of the opportunity for deception, varies according 
to the nature of the security. At the one extreme, the reputation 
of an old-estabUshed undertaking and the market record of its 
previous issues may form an adequate basis for a sound judgment 
of the value of a new issue offered in the market ; at the other 
extreme, where a new company is being formed to exploit some 
doubtful industrial opportunity, the material on which to form an 
estimate of its prospective yield is so inadequate that the opinion 
of the ordinary investor is practically valueless and his purchase 
is an act of faith rather than of judgment. The one kind of security 
shades off gradually into the other, and no definite line can be drawn 
between the two ; nevertheless, we may mark off from the group 
of industrials which we are now considering a number of stocls and 
shares whose conditions of sale are comparatively free from these 

opportunities for deception. 



In 1912 and 1913, according to The Times Prospectuses, only 
about one-half of the issues of home industrials on the London 
market arose from the formation of new joint -stock companies. 
A large part of these issues consisted therefore of applications for 
capital to be applied to the development of existing companies, 
many of whom were firms of established reputation such as Lever 
Bros, or Associated Portland Cement Ltd. Moreover, a few of 
these issues, such as those of Vickers & Borax Consolidated, took 
the simple form of an offer to shareholders. In addition (not 
included among these issues), there were each year brief notices 
from some fifty Gas and Water companies inviting tenders for small 
quantities of their stocks. These facts show that a considerable 
proportion of the securities issued on the London market are sold 
in conditions which are free from anything in the nature of deception, 
and that a small proportion are sold in a manner which is very 

It might reasonably be expected that in the Provincial markets 
local knowledge on the part of the investor, both of the business 
reputation of the vendor and of the prospects of his undertaking, 
would do a good deal to eliminate dishonest promotion and ensure 
that securities were sold at prices fairly near their investment values. 
There seems to be no doubt that this is true of the securities of 
cotton-spinning companies (cf. pp. 267-8). According to prominent 
business men in the industry, the great majority of the new com- 
panies formed in the years immediately preceding the war were 
sound concerns and all were sound in intention. The directors 
would not usually be large subscribers, but they and their friends 
would be likely to hold perhaps a quarter of the issue ; and the 
promotion would be governed by industrial rather than financial 
interests. A broker adds the opinion (Nov. 1919) that ** there is 
practically no scope for a professional company promoter, especially 
at Oldham." 89 The securities are rarely sold by means of a 
prospectus and are not underwritten ; they are placed by private 
negotiation among local people who understand the cotton trade. 
In this market at least, then, it would seem that the conditions of 
sale are such that securities are marketed both honestly and 

Information with regard to the Provincial issue of new securities 
is almost entirely lacking ; but it is clear at least that the conditions 
of sale just described are not typical of those in other local markets. 
In Newcastle, for example, according to the opinions of several 
brokers, new securities are sold with the aid of a prospectus and are 
underwritten either locally or by large London houses. Opinion 
differs with regard to the opportunities of the promoters with a 
purely financial interest. But, according to one broker : " There 


is plenty of scope at the present time (1920) for company promoters 
either in promoting a company or by taking a financial interest in 
underwriting, etc. The flotation is usually undertaken by bankers, 
trust companies, etc., and they call in stockbrokers who possibly 
relieve the promoter of a large amount of the stock." 

The formation in 1916 of B.S.T. Ltd. (British Shareholders' 
Trust) initiates an interesting and important development in the 
marketing of Provincial securities. The organization consists of a 
central Trust company in London and five allied companies in 
the more important Provincial centres. Its methods seem well 
adapted to reconcile the interests of promoter and investor and to 
facilitate the economical sale of securities. At each centre is an 
executive assisted by an advisory body elected from brokers 
nominated by shareholders of the Trust. It undertakes the market- 
ing of new securities, the underwriting of issues and the sale of 
large blocks of securities of deceased people. The shareholders are 
composed in a great measure of those connected with the manage- 
ment of large undertakings ; on the one hand, they bring to the 
notice of the Trust opportunities for profitable business ; on the 
other, they form a market in which the Trust may quickly and 
economically dispose of at least a part of its issue. The organiza- 
tion is a powerful one, the aggregate capital of the six allied Trusts 
amounting to nearly £2j m. It has already carried through a 
number of important issues and in one case underwritten an issue 
amounting to £16 m. 

Having separated in this rough way, and with some digression, 
a number of securities whose conditions of sale offer little scope for 
the effective use of superior bargaining knowledge, we may turn 
to consider what devices are available to check the opportunities 
for deception attaching to the large remainder of industrial securities 
offered in the London market. These devices lie partly in the 
organization of the market, partly in the provisions of the law ; 
they may be dealt with in that order. 

Reference has already been made (see p. 109) to the possibilities 
of an organization intermediate between the sources of Demand and 
Supply which should investigate the earning capacity of ventures 
in need of capital, select the most promising, and sell their securities 
to the investing public with an implicit assurance that the venture 
had a reasonable prospect of success. 

The history of the German Credit banks shows the great diffi- 
culties with which such an organization must deal, just as their 
success shows that these difiiculties can be overcome. The com- 
parative poverty of Germany about the middle of the last century 
and the great demand for capital to supply the needs of her rapidly 
growing industries led naturally to the development of bante 


which took a large and active part in providing the capital requisite 
to the creation and extension of business undertakings, both by 
the grant of long loans and the flotation of joint -stock companies. 
Prior to 1870 the banks often suffered heavy losses from their 
participation in industrial enterprise. So late as 1884, as is shown 
by the argument accompanying the new industrial law of that 
year, the formation of new joint -stock companies was associated 
with great evils : " . . . the leading promoters acted without 
any sense of responsibility and were exempt from any kind of 
control. . . . For a long time after its foundation the newly formed 
company possessed no corporate autonomy and remained defence- 
less in the hands of persons whose only object was their profit as 
founders. At the same time the public . . . had no reliable data 
whereby to form a correct estimate of the enterprise." In more 
recent times the banks have found it less necessary to take the 
initiative in industrial matters ; their policy has become more 
conservative ; "so far as newly formed companies are concerned, 
the broad results experienced during a series of years have led the 
banks to confine themselves as a rule to conversions of existing 
prosperous private undertakings into joint -stock companies and to 
co-operate in fusions and in increasing the capital of existing com- 
panies." " They hold aloof, however, as much as possible from 
investing money in perfectly new undertakings and from financing 
new methods of manufacture or inventions." "^^ In spite of a more 
sober policy, wider experience and more perfect organization, it 
would seem that unwise or unfortunate industrial loans have very 
frequently compelled the banks against their will to recover their 
capital by the conversion of the borrowing firm into a public joint- 
stock company, and that their industrial operations still occasion- 
ally involve them in difficulty and loss. The great success with 
which the German banks have promoted the development of industry 
and trade is universally admitted, but it should not be overlooked 
that such work is attended by much difficulty and heavy risks. 

An organization of this kind, intermediate between the sources 
of enterprise and the sources of capital, must evidently possess 
machinery for investigating business ventures, financial strength 
adequate to sustain the heavy risks to which it is exposed and the 
reputation and business connexions necessary for the efficient sale 
of securities to the public. An organization such as the Deutsche 
bank possesses these qualities in a high degree. Its practical 
administration (1914) is in the hands of a body of nine managers, 
all of them men of wide business knowledge, one or two of them 
admittedly of exceptional ability. It has a distinct staff of some 
eight or nine industrial experts, usually drawn from industry 
itself, and a highly developed department of information, while its 


system of unsecured advances keeps it in the closest touch with the 
position and progress of business concerns. It is easy to see that, 
with able management and machinery of this kind, the risks of 
industrial banking are greatly reduced ; business ventures in need 
of capital can be thoroughly investigated and the development of 
the more promising enterprises may be promoted with a reasonable 
prospect of success. Even so the risks are heavy ; for in the 
course of its growth the Deutsche bank has had " to write off 
repeatedly serious losses on account of participations and industrial 
business,"'^ though these were incurred apparently mainly in 
connexion with its commitments abroad. But apart from the 
possibilities of actual loss there is always the danger that the 
fortunes of the bank may be bound up for long periods with the 
prosperity of the industries in which its resources are employed. 
To meet these risks the Deutsche, like other German Credit banks, 
employs a paid-up capital very large in proportion to its deposit 
liabilities ; it shifts the risks of some of its operations to sub* 
sidiary companies specially formed for the purpose,''^ and in large 
undertakings acts at the head of a very powerful group of allied 
banking and financial houses. Its great reputation, its branches 
and its " communities of interests " with banking houses through- 
out Germany naturally facilitate the marketing of the securities of 
the business concerns with which it is specially associated. How 
effective the wide connexions of a great bank may be in facilitating 
the sale of securities is shown by the ability of the Credit Lyonnais 
to sell to its depositors, in four or five days, stocks to the value 
of 40 or 50 million francs.''^ g^t the responsibilities of the German 
banks are not ended even when a successful issue has transferred 
to the public the task of supplying capital to these concerns. They 
retain some measure of influence, partly by representation on 
the controlling boards, partly by the holding of shares, partly by 
the voting power of the proxies entrusted to them by shareholders 
who are at the same time their own customers. The fact that the 
members of the managing bodies of the Deutsche banks are repre- 
sented on the boards of more than two hundred undertakings 
engaged in the most varied kinds of business is a somewhat impressive 
illustration of its immense responsibilities, and of the part it has 
played in supplying the capital required for the industrial develop- 
ment of the country. 

It was suggested on pages 126-7 ^^^.t the reasons why no organi- 
zation on this scale had developed in England lay partly in the less 
rapid growth of our industries and in the large profits available 
for reinvestment in expanding businesses. But, whatever the 
reason, the fact remains that such agencies play very little part in 
the marketing of industrial securities in this country. 


The great Issue Houses do some work of this kind ; on the 
question how much more they could do, experts differ. "If," says 
Professor Foxwell, " our great Issue Houses would take up this 
work their help would be invaluable. They are accustomed to 
make exhaustive examinations of propositions submitted to them. 
They employ expert engineers, accountants and lawyers ; and 
every pertinent detail in regard to process of manufacture, plant 
management, earnings, labour conditions and past history is taken 
into account. But the Issue Houses fight shy of ordinary home 
industrial propositions. They prefer those put forward by foreign 
Governments, municipalities, or the very largest transport com- 
panies. As a rule our English industries are too small in scale 
to attract the Issue Houses ; the securities would not be market- 
able."^* Whether these Houses are restrained from marketing 
home industrials by lack of adequate machinery for investigation, 
as they have sometimes maintained, or by the proportionately 
greater trouble of dealing in smaller operations, the fact remains 
that many ventures, possibly with excellent prospects, are laid 
before them and rejected ; and that the part they play in this 
work is of insignificant dimensions. 

A small group of minor financial houses, composed principally 
of Trust and Investment companies, also takes part in the marketing 
of home and foreign industrial securities, but to a very limited 
extent. Their intermediation no doubt increases the price paid 
by the investor ; but it can hardly be doubted that it carries 
with it some sort of guarantee that the security purchased has a 
reasonable prospect of paying a fair dividend. 

The growth of these intermediary organizations has been 
stimulated as a result of war, partly specifically, partly by the 
general loosening of traditional ideas. One notable result has 
been the formation of the British Trade Corporation designed, 
among other objects, to investigate the possibilities of business 
ventures in need of capital, to supply the needs of the more 
promising, and ultimately to undertake the sale of their securities 
to the public ; several issues have already been marketed by the 
Corporation. More general effects are illustrated by one or two 
cases in which the responsibility for the marketing of home in- 
dustrial securities has been assumed by an English Joint-Stock 
bank, and by somewhat increased activity on the part of the minor 
financial houses referred to above. This stimulus may be important 
in its promise, but its immediate influence on the manner in which 
securities are marketed is not large. It is still true that the vast 
majority of industrial stocks are sold without the assistance of any 
permanent intermediary agency. 


IN the absence of strong intermediary agencies with machinery 
available for the investigation of industrial propositions 
and the organization requisite for the efficient marketing 
of their securities, the work of selecting profitable new 
ventures, of capitalizing their prospects in terms of securities and 
of selUng those securities to the public, falls mainly to the com- 
pany promoter ; while that of marketing further issues of existing 
companies is undertaken mainly by the companies themselves. 

"The facilities provided by the promoter are," says Professor 
FoxweU, "a mere makeshift, ' utterly inadequate ' " ; and it is not 
difficult to see that his methods of operation contain within them- 
selves strong tendencies to over-valuation and to heavy marketing 

The promoter is not a very definite kind of person. He may be 
a parent company engaged in the formation of a subsidiary or allied 
business enterprise ; he may be, and very often is, the vendor 
of the assets purchased by the new company ; '® or he may be a 
financier whose contact with the new company ceases when he 
has completed its flotation and sold any shares which may have 
been allotted to him. But whoever he may be, his interests as 
promoter are quite distinct from those of the company he forms. 
This is most clearly seen when a company is floated by a financier, 
by one whose interest lies only in the process of promotion. 

It is characteristic of the London market that its financiers are 
moved mainly by financial as distinct from industrial interests ; 
they prefer to employ their capital for short periods and to draw from 
it a purely financial profit rather than commit it to the uncertain- 
ties of business enterprise ; they are unwilling to adopt the plan, 
common in Germany, of associating themselves with the fortunes 
of a new venture until it has proved its worth and can suitably be 
sold to the investing public. Accordingly, when a new company 
is floated by a promoter, his interest is in general bound up, not 
with the ultimate earning power of the venture, but with the differ- 
ence between the price at which he buys from the vendors and the 
price at which he sells to the pubhc. So far, therefore, as his 


influence governs the conditions of the flotation, there is inevitably 
a strong tendency to over- valuation. In many cases, no doubt, 
this tendency is checked by the industrial interests of the promoter 
himself, or of the parties with whom he is associated ; for example, 
the vendor of an old-established business may retain a substantial 
interest in its fortunes, while the business reputation and interests 
of other parties concerned may be dependent upon the success of the 
venture. It may be admitted that in many cases the predominance 
of industrial interests ensures that the company is reasonably 
capitalized. But it remains true that there are many opportunities, 
especially in times of boom, which enable the promoter to sell to 
the public the securities of new companies whose capital is far in 
excess of the prospective earning power on which it is based. We 
have to consider the manner and degree in which these opportunities 
are restricted. 

Some measure of the value of a new issue is given by the stand- 
ing of the broker whose name appears on the prospectus. The 
appearance of the name of a reputable broker would not, indeed, 
show that he had investigated the prospects of the venture, but 
it would usually carry with it the assurance that he had satisfied 
himself as to the business integrity of the responsible parties. In a 
considerably less degree the name of the banker carries a similar 
assurance ; for a large joint -stock bank does not willingly associate 
itself with worthless issues. Further, the official list of quotations 
enables the investor to strengthen his judgment by comparison 
of the price of similar issues, while invaluable assistance is given by 
the impartial criticism of the more independent part of the financial 
press and the expert advice of the investment broker. It seems not 
too much to say that if the investor would only make reasonable 
use of these facilities he would receive ample protection from the 
unscrupulous company promoter. In fact, however, he does not do 
so ; for every year some millions of pounds' worth of securities 
are sold at prices well above their investment values. It would be 
an easy conclusion that, inasmuch as loss arising from unintelligent 
action forms a penalty, an evil which tends to bring about its own 
cure, these speculative losses might be left unhindered to work 
out their effects in rationalizing the conduct of the investor. But 
this ideal is distant and the waste of resources large. Meanwhile, 
therefore, any protection which the law can give may be welcomed. 
The main principle on which English law proceeds in order to 
lessen these evils is that of enforcing publicity of matters requisite 
to the formation of a sound judgment of the value of a new issue ; 
it endeavours to equalize the bargaining knowledge of seller and 
buyer. The prospectus, the document in which the company 
publicly offers its securities for sale, must among other matters 


contain information on the following essential points. As it is 
clearly of the first importance to the investor to know the value of 
the assets acquired by the company, the law requires that the 
prospectus should disclose the price paid to the vendor. This 
requirement is not a strong one ; it does not make provision for any 
independent valuation of the assets purchased by the company ; 
it does not even require that the price at which the vendor himself 
may have bought the property should be stated ; and it does not 
prevent unscrupulous directors from concealing the information 
required by including it among a multipUcity of minor contracts. 
For obvious reasons the law requires that the names, qualifications 
and remuneration of the directors should be stated, together with 
full particulars of any interest they may have in the promotion 
or in the property acquired by the company. It requires, too, 
the contents of the Memorandum of Association, particulars with 
regard to founders* shares, etc., and provision for the inspection of 
material contracts. The minimum subscription on which the 
directors will proceed to allotment must be given ; for " inadequacy 
of capital has been one of the most frequent causes of disaster in 
joint -stock companies." ^^ Further, the prospectus must show the 
amount of the underwriting commission, the payment to the pro- 
moter and in general the amount of the preliminary expenses. In 
addition to these provisions for the publication of essential facts, 
the law places the promoter in a fiduciary position in relation to the 
company, so that he may not make any profit at the company's 
expense without its knowledge and consent ; and it makes directors 
liable for any false material statement in the prospectus unless they 
can prove that they had reasonable grounds for believing the state- 
ment to be true and did so believe. 

It is evident from the nature of these provisions and from the 
facts of the market that the requirements of the EngHsh law do not 
destroy the opportunities for deception open to the unscrupulous 
promoter ; moreover, the spirit of these provisions may be in part 
evaded by the frequent practice of publishing an abridged prospectus 
containing the more attractive facts, together with a reference to 
some office at which copies of the full statement may be obtained or 
inspected. As an indication of further legal possibiHties, some 
points may be noticed where the legal requirements of foreign 
states are more stringent than those of this country. 

One of the weakest points in the English law lies, it was noticed, 
in the lack of any requirement for an independent valuation of the 
property taken over by a company. In France, the value of the 
assets acquired by a public Hmited company and the consideration 
for any profits granted to promoters must both be examined by a 
committee of scrutineers appointed by the shareholders and approved 


by the shareholders themselves. In Germany, a Committee of 
Inspection, composed of directors and shareholders, examines and 
reports on the assets transferred to the company, as disclosed 
by the declaration of the promoters. 

There are advantages in preventing companies with a small 
paid-up capital from displaying an immense nominal capital for 
the purpose of obtaining undue credit from the public ; and further, 
though not unmixed, advantages in requiring that shares shall be 
of a certain minimum amount, in order, as a director of the Dresdner 
bank expressed it,'^ " to confine investments in stocks of companies 
... to people of means and responsibility, ..." and in order to 
restrict speculative operations by people of small means. English 
law is little concerned with this. In 1891, for example, a company 
was registered in England with a capital of 9,600,000 shares of Jd. 
each, the total actually subscribed being ifd. ; and there seems to be 
no legal obstacle to a similar issue at the present time. French law 
regulating the formation of public limited companies is much more 
stringent. It requires : that the nominal value of shares shall be 
at least 25 francs ; that the authorized capital shall be subscribed 
in full ; that 25 franc shares shall be fully paid up and that at least 
one-quarter shall be paid up on shares of larger denomination. 
In Germany, the shares of such companies must be of a minimum 
nominal value of 1000 marks, though this limit may be reduced 
to 200 marks in certain special cases. Except when the promoters 
take up all the shares themselves, the company is not legally formed 
until the whole of its share capital has been subscribed and fully 

A further point of difference lies in the fact that English law 
is content to entrust the financial stability of a public joint -stock 
company to the ability and integrity of its directors. Both France 
and Germany, on the other hand, require that 5 per cent of the 
annual net profits shall be placed to reserve until the company has 
accumulated a fund equal to 10 per cent of its nominal capital. 
German law goes further ; it compels the company to make pro- 
vision for the depreciation of fixed assets, and to write off formation 
expenses ; such expenses may not, as in England, be included among 
the assets in its balance sheet. '^ 

It is difficult to believe that among these and other legal devices 
of foreign States there is nothing which could be adapted to improve 
the company law of this country, more especially as our law, accord- 
ing to Prof. Foxwell, " is less exacting in its safeguards than that of 
any other great business community, except, perhaps, the State of 
New Jersey." s" How urgent the need for amendment is, must be 
judged partly by one's confidence in the power of freely developing 
organizations to eliminate, themselves, their moral and technical 


defects, partly by the magnitude of the social evil awaiting remedy. 
Various estimates showing immense losses falling on the public 
from their association with joint -stock companies are given by Dr. 
Stamp in his British Incomes and Property ; but his criticism of 
these figures is too thorough to make it necessary to quote them 
here. Some idea of the magnitude of these losses may perhaps be 
derived from a Board of Trade return ®^ showing that in 1896 no less 
than 1261 companies went into liquidation, involving a loss incom- 
pletely estimated at £15 m. The full loss, amounting, perhaps, to 
£21 m., is large and of course relates only to companies actually 
wound up ; but it is less than ij per cent of the £1500 m. at that 
time invested in joint-stock companies and exposed to the ordinary 
risks of business. 

The manner in which losses of this kind may occur is shown by an 
article in the Investor's Monthly Manual,^'^ which distinguishes two 
kinds of prospectus : those expressing a demand for capital, and 
those responding to a public demand for shares. It says, " The 
typical boom company, as we have pointed out, sees the light only 
because the public is on the feed ; the properties are bought up from 
their original owners by syndicates which know very little about 
them, and are probably incapable of judging their true value ; the 
syndicates are eager to buy, and as there are many promoters in the 
market all pursuing the same object, they are likely to pay a fancy 
price for whatever they acquire. Then they have to make their own 
profit, which increases the capitalization, and so by the time the 
property is in the hands of the public it is valued at a very generous 

The impression given by these various considerations is borne 
out by the opinion expressed by a strong committee appointed in 
1905 " to inquire what amendments are necessary in the Acts 
relating to Joint-Stock Companies. ..." " We have already 
expressed an opinion," they say, " that the number of companies 
into the management or formation of which fraud enters is small in 
Comparison with the number of sound undertakings registered and 
working under the Acts, and this being so, the dishonest director 
is the exception. We think that nothing could be more un- 
fortunate than that provisions designed for checking and punishing 
dishonesty or gross negligence should be turned into an engine of 
oppression for honest and prudent men."^^ 7^15 opinion may be 
supplemented by that of Sir F. B. Palmer, one of the highest legal 
authorities on the subject. He says, "... the provisions of the 
Act [of 1908], interpreted and supplemented by the many important 
decisions of the Courts, . . . form together a comprehensive and, in 
most respects, admirable system of law ... a system which con- 
trasts very favourably with the complicated formalities and the 


hard-and-fast regulations and restrictions imposed by not a few 
foreign systems of law in regard to companies and co-operative 
enterprises. Unlike these systems, the policy of our law has been to 
accord the utmost liberty in regard to the formation, the carrjdng 
on, and the dissolution of companies ; and although this freedom has 
at times been abused by unscrupulous persons for their own ends, 
necessitating the intervention of the legislature, such abuses are 
but an insignificant item in comparison with the vast amount of 
honestly formed and honestly managed companies."^* 

In this discussion we are dealing with vague ideas. The evils of 
fraud merge gradually into those of superior bargaining power, 
and these evils pass gradually into those of excessive marketing 
expenses. Although the number of fraudulent companies may be 
only a small proportion of the whole, there is a much greater 
number in whose flotation an unduly large fraction of the public 
subscriptions is absorbed by the agencies composing the market. A 
part of this capital is diverted to promoters, vendors and other 
parties as a result of the superior bargaining knowledge which 
enables them to sell properties far above their investment values. 
This is undoubtedly an evil, but it is mainly a transfer rather than a 
destruction of wealth. A second part of the capital lost by the 
public has a greater social significance, for it is entirely dissipated 
in the excessive marketing costs often necessary to persuade the 
public, rightly or wrongly, of the worth of the venture. 

It is only to be expected that the costs at which a small industrial 
venture obtains its capital through this market should be rather 
heavy. It is demanding capital from a public which knows nothing 
of it, and is offering as security only its prospective earning power ; 
in addition, therefore, to the expenses of its formation it must expect 
to pay heavily for the advertisement by means of which it can 
effectively present its case, and for the borrowed reputations of the 
broker and other parties by which that case is supported. Further, 
this particular method of obtaining capital by way of a public offer 
of shares involves risks peculiar to itself, for if the issue fails it cannot 
in general be repeated ; the venture stands or falls on this chance. 
The company must, therefore, usually be prepared to insure against 
this risk by paying an underwriting commission, 

** The cost of an issue," says Mr. Lowenfeld, " depends entirely 
upon the number of prospectuses sent out, the amount spent on 
advertising, the fees paid to the bank which receives the applications, 
to the brokers, solicitors and accountants whose names appear on 
the prospectus, and the cost of the underwriting fee. These ex- 
penses are very heavy in any case, and hardly ever amount to less 
than £2000 even on a modest issue. But as there are some firms of 
brokers and solicitors who consider themselves but poorly remuner- 


ated by a fee of 1000 guineas for merely giving the promoters the 
right to print their name on a prospectus, their work and out-of- 
pocket expenses being paid extra, and as it is quite easy to spend 
£5000 on advertising a prospectus, the cost of launching some issues 
very considerably exceeds the smallest sum which can be ex- 
pressed in five figures. Whenever the issue is large this does not 
matter, as even £25,000 is only 2J per cent of £1 m. ; but on 
small issues of £50,000 or £100,000 the expense is proportionately 
burdensome." 86 

Mr. Lowenf eld's opinion seems to be a fair statement of pre-war 
marketing costs ; his figures must , of course, be increased in adaptation 
to post-war conditions. A general figure representing the average 
cost of marketing industrial securities would evidently have little 
meaning, by reason of the wide differences in the size and reputation 
of the companies and the market conditions at the time they were 
floated ; but certain general inferences may be drawn. 

It is clear that the smaller, the more obscure, and in general 
the more worthless the undertaking seeking capital in this market, 
the heavier are likely to be the expenses of the advertisement by 
which the public is persuaded to subscribe, and the underwriting 
commission by which the issue may be insured against failure. An 
idea of the pressure exerted by the opportunities for deception may 
be seen in the rates paid for underwriting, which amount frequently 
to 10 per cent, sometimes to 25 per cent and occasionally to more 
than 50 per cent on the portion of the issue underwritten.^ Further, 
while the costs of marketing the stocks of the smaller and more ob- 
scure undertakings may form a heavy deduction from the capital 
subscribed by the public, those involved in the marketing of large 
issues of sound industrial stocks and gilt-edged securities may 
constitute only a very small fraction of the capital supplied. From 
these facts, and the circumstances that the opportunities for over- 
valuation are much smaller in the latter than in the former kind of 
issue, we may infer that the English market for new Stock Exchange 
securities is much better adapted to supply capital to such bodies 
as foreign states, railways and other large undertakings than 
to meet the demands arising from small industrial ventures. But, 
while it may be admitted that the market is most efi&cient in supply- 
ing large quantities of capital to reputable bodies, it must be recog- 
nized that its wastefulness in meeting the needs of smaller ventures 
might be largely remedied by the development of strong inter- 
mediary organizations, and that, even without these organizations, 
it performs an important service in making capital available for 
risky commercial and industrial experiments at home and abroad. 


WHEN securities have once been sold through the 
agency of the Issuing Houses, the Company Promoter 
and so on, they depend for their subsequent marketa- 
bihty upon the organization which it is the business 
of the present chapters to discuss. This organization extends 
throughout the entire country, varying in form from the highly 
developed market to the informal arrangements of the country 
broker and auctioneer. 

At one extreme is the vast organization of the London Stock 
Exchange, perhaps the most highly specialized market in the 
world. About it, as about the New York, Paris and Berlin Bourses, 
is a market composed of " outside " dealers, uncontrolled by the 
regulations affecting members of the organized market. " In 
London," says Mr. Powell, "... the honesty and substance, of 
some of the big ' outside ' firms are beyond question," but they 
are, perhaps, not so representative of this market as are the " bucket 
shops " and similar firms who, having no reputation to lose, use 
their superior bargaining knowledge without restraint to make 
gains at the public loss. As an illustration of the activities of 
this market Mr. Powell may again be quoted. Speaking of 
securities unquoted on the Stock Exchange he says, *' At the 
moment [1910], for instance, there are something like 200 
skating rink enterprises, with capitals of less than £20,000. . . . 
Where there are many shares of a particular class, e.g. the rink 
shares already mentioned — an enterprising broker here and there 
will constitute himself the market in them. If he is an ' outside ' 
broker he will send out circulars by the thousand, offering to buy 
or to sell. These shares form in truth the bulk of those quoted 
by the great financial dailies." ^' 

Next in order of development come the large Provincial Stock 
Exchanges at Manchester, Sheffield, Newcastle, Cardiff and some 
fourteen other important centres. Large absolutely, these markets 
are small comparatively ; the membership of the Liverpool Ex- 
change, for example, being 150, or about -}^ that of London ; 
further, there is no technical, though there is a partial practical, 


distinction in these markets between the broker and the jobber. 
These Exchanges deal mainly in such securities as local industrial 
and municipal stocks. Not wholly, however, for Glasgow, largely 
a speculative market, deals widely in Oil shares and Birmingham 
is an important centre for Cycle and Rubber Tube Stocks. 
Sheffield deals especially in iron, steel and coal securities ; 
Manchester with textiles. Quotations in these markets depend 
mainly on local information with regard to industrial conditions ; 
they do not vary, as gilt-edged securities and debentures do, 
with monetary and political conditions, nor do they take their 
tone from London. ^^ 

Some of the smaller Exchanges, e.g. Oldham, exist mainly as 
centres at which brokers meet weekly to compare prices pre- 
paratory to the issue of the Stock and Share List, most buying and 
selling being done off the Exchange by individual negotiation. 
By means of the telephone linking brokers with one another, the 
whole of the North of England seems to be practically one market 
for many of the securities in which it is interested. 

Finally, there are the smaller Provincial towns where there 
is no price list and the market is formed by one or more stock 
and share brokers, who may, perhaps, combine this work with that 
of an estate or insurance agent. The work done by these brokers 
is limited, in some parts of the country at least, to that of finding 
a buyer or seller in response to a request from a customer to sell 
or buy. In response to a request to deal in some local security 
they would perhaps give a quotation, but their customer might 
have to wait long for the discovery of another party willing to deal 
in the opposite direction. A supplement to these facilities is found 
in the public sale of securities occasionally arranged by firms of 

It may not be assumed that this organization, extensive as 
it is, enables all securities, or even any very large proportion of 
them, to be readily marketed. Even on the London Stock Ex- 
change, as is well known, the quotations of many securities are 
only nominal ; they have no active market and can be dealt in 
only at a considerable sacrifice in price. Provincial markets 
are naturally far less effective ; many small but sound local in- 
dustrials can neither be bought nor sold within any reasonable 
margin of price or period of time ; the holders of such securities 
are often, in this respect, in a position little better than partners 
of the business ; and they must normally be paid a high rate of 
return to compensate them for their inabiUty to recover their 
capital at will. According to Mr. Lowenfeld, " There are over 
35,000 investments in Great Britain, of which only about 5000 
are officially quoted on the British Stock Exchanges, and of all 


these less than 400 have at any time a free market. These 400, 
however, are constantly changing, some dropping out and others 
taking their place." 89 

In discussing the organization for marketing old securities, 
therefore, it is very necessary to bear in mind that the conditions 
in which the majority of securities are bought and sold are very 
different from those found in the London market. In the following 
pages the discussion will be limited to the conditions of the London 
Stock Exchange, because the characteristics of the market are 
naturally most clearly seen where its organization is most highly 
specialized ; but this limitation is made on the understanding 
that London is regarded as representative, not of the organization 
as a whole, but of its most highly developed form. 


THE pictorial writings of Mr. Hartley Withers, Mr. Duguid 
and a host of other writers make it more than unneces- 
sary to give any descriptive account of the London Stock 
Exchange. All that is required here is to indicate some 
of the general characteristics of the market, and those features 
of its organization which are essential to an understanding of its 
functions. The details of this organization are more conveniently 
dealt with in the following chapters, where the operations of the 
speculator are examined. No account is given here of the effect 
of the temporary restrictions laid on the market during the war ; 
for there seems every reason to suppose that the last of these 
restrictions wiU be removed before long and that the nature of its 
operations will remain substantially that of pre-war days. 

It has already been noticed that although the Stock Exchange 
is ancient in origin, its principal development, like that of the 
railway, has taken place during the course of the last hundred 
years. The growi;h of the London Stock Exchange during this 
period has been encouraged by a freedom from legal control which 
is in sharp contrast with the rigid State regulation of the Berlin 
and Paris Bourses, and by the immense volume of our foreign 
investments which largely determines its character as an inter- 
national market. In speculative activity and in turnover it is 
surpassed by the New York Exchange ; but in size, measured 
either by the number of its members or the volume of the securities 
in which it deals, it exceeds that of any other market in the world. 
The London Stock Exchange, although a unified body, soon, 
perhaps, to be under the single control of a committee of manage- 
ment, is more conveniently regarded as a group of markets ; for 
it is subdivided into groups of jobbers, each group specializing 
in a comparatively narrow range of securities and " making a 
market " in them by their willingness to buy or sell a reasonable 
amount in response to the demands of the expert agents of the 
public — the brokers. These sub-markets are connected with one 
another ; partly by a psychological afiinity, for they are all 
formed by groups of men subject to the contagion of depression 



or optimism ; partly by the fact that money forms one side of 
every transaction throughout the Exchange ; so that a variation 
in money rates is likely to affect all the sub-markets in the same 
way, though, no doubt, to a widely different extent. But in 
spite of these common influences the various sub-markets are 
largely independent of one another, for the characteristics of each 
are naturally determined in the main by the nature of the securities 
in which it deals and the temperament of the particular group 
of the public whose operations it carries through. The incidents 
of the market for municipal stocks or similar investment securities 
necessarily differ very widely from those of what Mr. Withers 
could orice call the " boiling whirlpool of the Kaffir Circus." 

Bearing these differences in mind, let us pass on to consider 
the function of the Stock Exchange as a whole ; let us endeavour 
to distinguish the economy which it effects in the social organiza- 
tion, and the principal conditions on which the efficiency of its 
work depends. 

This economy may be expressed in several ways, each of which 
is useful in its own field. We may begin by recalling a general 
conception expressing it in terms of a reduction of the efforts and 
sacrifices involved in the supply of capital. The market for new 
securities, as already noticed, links the group of capitalists who 
possess capital, with the group of business men and other parties 
who employ it. By means of this market capital is carried from 
one group to the other ; and, as a result of its activities, there 
remains in the hands of one group a vast amount of capital, and 
in the hands of the other group a corresponding amount of securities 
involving a continuous supply of Waiting and Risk-bearing. The 
organization of the Stock Exchange lies within this latter group of 
capitalists, and its work consists in facilitating the transfer of 
securities among the members of the group. These facilities for 
the rapid and convenient exchange of securities yield an important 
social economy ; they enable the burden of Waiting and Risk- 
bearing to be continuously shifted from one capitalist to another 
in accordance with the exigencies of his particular circumstances ; 
they enable this burden, therefore, to be continuously shifted to 
those who from time to time are most willing to assume it and will 
bear it at the lowest price ; in other words, they lower the real 
costs of maintaining outstanding the stock of capital transferred 
to other parties by the market for new securities, and consequently 
lower its supply price. It follows that by means of this organiza- 
tion each capitalist is enabled to supply capital in the quantity 
and for the period which is most convenient to him. Accordingly, 
by slightly shifting the point of view, we may regard the Stock 
Exchange as a device which adds together small quantities and 


short lengths of capital, and by increasing the quantity coming 
forward lowers its supply price. 

In case these general conceptions may appear to be rather 
remote from actual practice it may be as well to connect the two 
by retracing the argument from the basis of particular operations. 
The Stock Exchange facilitates the exchange of securities. By 
enabling securities to be bought quickly and cheaply it encourages 
investment, and so increases the quantity of capital coming forward. 
By enabling securities to be sold quickly and cheaply it relieves the 
investor from most of the insecurity to which he would otherwise 
be exposed in supplying capital for uses from which it cannot readily 
be withdrawn. This last consideration is especially important ; 
for the purchase of new securities generally involves the supply of 
capital for very long periods, and it is only reasonable to suppose 
that but a small part of this capital would be supplied were it not 
for the work done by the Stock Exchange in enabling the investor 
to recover the market value of his security, not from the party to 
whom he has supplied his capital, but from some other party with 
resources available for investment (cf. p. 94). The importance 
of this consideration is illustrated by the fact that the control of 
the Treasury over the issue of new securities during the course of 
the war has been exercised solely by withholding the advantage of 
quotation and, therefore, of purchase and sale on the Stock 

The Stock Exchange, the market for old securities, is then an 
organization within the group of capitalists, intimately connected 
with the market for new securities lying between the group of 
those who supply capital and the group of those who employ it. 
It may be regarded as a device for reducing the real costs of supply- 
ing the Waiting and Risk-bearing associated with the outstanding 
stock of capital ; or as a device for making short lengths and small 
quantities of capital available in large amounts for long periods ; 
or as an organization providing particular advantages to individual 
buyers and sellers ; but in all cases its ultimate social economy 
may be expressed in the same terms, namely, in its influence in 
lowering the supply price of capital. 

The work done by the Stock Exchange in lowering the supply 
price of capital depends then on the efficiency with which it facili- 
tates the transfer of securities ; this efficiency, in its turn, depends 
on a set of conditions which we have now to examine. 

It must be noticed, in the first place, that the efficiency of the 
market is to be measured, not simply by its effects in facilitating 
the exchange of securities, but by its effects in facilitating their 
exchange at a price. An investor who wishes simply to buy or sell 
can do so, if he chooses, without using the services of the market ; 


he has only to offer a sufficiently attractive price and he will at 
once call forth sellers or buyers. But if he wishes, as of course he 
does wish, to buy or sell at a price as close as possible to the true 
value of his security, he is likely to find it difficult, if not im- 
possible, immediately to find a party with whom he can deal. It 
is evident, therefore, that the efficiency of the market must be 
measured by its effects in enabling securities to be quickly and 
cheaply bought and sold at prices as close as possible to their true 

This definition at once raises the question — What is the " true " 
value of any security ? It seems safe to say that theory can give 
no perfect answer to this question ; for human valuations depend 
on many unstable influences, and philosophers are unlikely to agree 
in the selection of those which do and those which do not affect 
" true '* value. If, for example, a short spell of dull weather 
makes risk-bearing more onerous and momentarily lowers the 
market price of speculative securities ; or if the small possibility of 
exceptionally large dividends from mining securities, by exercising 
an influence on the investor's mind out of all proportion to their 
actuarial value, causes the value of such securities to be maintained 
at an unreasonably high level ; or if sympathy with a belligerent 
State raises the value of its stocks ; should these causes be reckoned 
among those which determine what one vaguely conceives as the 
true value of these securities ? But if perfect accuracy of concep- 
tion is unattainable, an approximation sufficiently close for present 
purposes may, perhaps, be reached on the assumption that the current 
price of any security should correspond to the actuarial value of 
its prospective yield as estimated by well-informed market opinion. 
In other words, its price should be such as would give the purchaser 
a reasonable expectation of obtaining a return equivalent to the 
net rate of interest, plus normal earnings of management for the 
business ability exercised in undertaking the risks and trouble 
involved in the investment .w 

If the market price of securities were determined on this basis 
it would be broadly true that no stock would ever be " dear " or 
" cheap " to purchasers in general. The investor, buying at random 
consols or rubber shares, would know that in the opinion of the 
market his purchase would yield him a normal return on the services 
he would be called on to supply ; and his choice between one security 
and another would be determined almost entirely by his capacity 
and inclination to undertake the requisite work of management. 
This conception is no more than an approximation. It leads to 
a definition of the " true " value of a security as a price such that 
the investor may reasonably anticipate a return equal to the sum 
of the supply prices of pure Waiting, and of the business ability 


employed in management (cf. p. 80). That being so, let us call 
this price the Investment Value of the security and estimate the 
work done by the Stock Exchange in terms of its ef&ciency in 
facilitating the exchange of securities at prices approximating as 
closely as possible to their Investment Values. 


THERE appear to be two main conditions which deter- 
mine the abiUty of the market to faciHtate the exchange 
of securities at prices approximating closely to their 
investment values : the first is the number of people 
whom it brings into business contact ; the second is the nature 
of these people, in particular their reasonableness and financial 

It is clear that the larger the number of people whom the market 
brings into business relations with one another the smaller is the 
price change necessary to call forth a buyer or seller in response to 
a demand to sell or buy, and the smaller, consequently, is the 
divergence from investment values due to difficulties of marketing. 
In actual practice the advantage of large numbers shows itself in 
the form of a narrowing of the jobber's " turn " ; for the greater 
the number of people composing the market for any security, the 
greater is the jobber's assurance that he will be able readily to 
" undo his bargain " and complete his operation, and the narrower, 
consequently, is the margin between the prices at which he is 
prepared to deal as buyer or seller. It is a commonplace that 
securities which form part of a large issue, and are dealt in readily 
at a small margin of price, maintain a higher average value from 
their easy marketability. On the other hand, investors are natur- 
ally rather shy of small issues ; partly, perhaps, because they cannot 
buy readily, but mainly because if a change in their circumstances 
requires them to sell out quickly, they cannot do so without an 
appreciable sacrifice in price. A small market in any security is 
likely, therefore, to result in a twofold tendency for the price of the 
security to diverge from its investment value : the price will be 
easily driven up and down by the individual pressure to buy and 
sell, and the average price will be depressed by difficulties of market- 
ing. The same conclusion may be expressed in positive terms 
by saying that a large market, by increasing the volume of dealing, 
lowers the costs of marketing, and by so doing maintains prices in 
closer confromity with investment values. This consideration is 
no doubt partly responsible for the growing practice on the part of 

municipalities of raising money by way of collective public issues. 



The organization of the Stock Exchange contributes directly to 
increase the numbers in the market ; for it brings into business 
contact with one another both people who are separated by space 
and people who are separated by time. The jobbers who form, 
as it were, the core of each of the markets on the London Stock 
Exchange, are usually prepared to buy or sell on demand, subse- 
quently undoing their bargain by dealing either with a second 
party who is already in the market or with some party who may 
appear in the market at a later date. By way of illustration we 
may suppose that an investor sells a stock, through his broker, to 
a jobber who deals in that particular security. If the jobber 
resells that stock on the same day to a broker representing a second 
investor we may regard his operation as one linking two investors 
separated by space. But if he is unable to find a party to whom 
he can sell immediately, he must carry the stock until a second 
investor appears in the market in the form of a buying order through 
his broker ; and the operation of the jobber must, then, be regarded 
as one linking two investors separated not only by space but also 
by time. 

But although the organization of the Stock Exchange is an 
important influence in widening the market, the numbers of people 
in any particular market must be largely determined by other 
conditions. As already noticed, the quantity of a security itself 
affects the size of its market. Its quality is hardly less important, 
for a speculative rubber issue is likely to draw into its market a 
much larger number of the public than a sound debenture stock of 
similar amount. So, too, with regard to the denomination of the 
security ; an issue of £1 shares is likely to be more widely held than 
a similar issue of shares of £5. Moreover, the size of the markets is 
influenced by more general conditions, such as the development 
of the tape machine, the financial press and other forms of com- 
munications, the wealth of the population, their tendency to specu- 
lation and their taste in investment. 

The efficiency of the Stock Exchange depends to a considerable 
extent upon the numbers of people whom it brings into business 
relations with one another ; but it depends, perhaps, even more 
upon the quality of these people. For if securities are to be ex- 
changeable at or near their investment values, the market must be 
able to maintain prices against buying and selling pressure which 
originates in undue optimism or depression ; it must be able to 
protect the current prices of securities against fluctuations due to 
influences other than those which rightly enter into the deter- 
mination of their investment values. 

The composition of any particular market is naturally deter- 
mined largely by the nature of the security in which it deals ; 


sound stocks which yield a steady return attracting the conserva- 
tive investor ; risky securities of more uncertain yield attracting 
the more speculative members of the public. But, given this 
general condition, the power of any market to prevent prices from 
being driven above or below their true level necessarily depends 
on the character of the particular group of whom it is composed ; 
the more largely it is composed of people whose operations are 
governed by emotion and limited by financial weakness, the more 
likely is it to be a weak market with an unstable level of price ; 
on the other hand, the more largely it is composed of strong 
capitalists, whose operations are governed by intelligent estimates 
of future yields, the more likely it is to be a strong market with a 
level of price conforming closely to investment values. 

These general considerations are developed more fully in later 
chapters ; at the moment we need do no more than indicate the 
manner in which the efficiency of the market is influenced by the 
operations of some of the different types of people who compose it. 

There are considerable numbers of people among the general 
public who dabble in speculative securities with practically no 
knowledge of their value and with very limited resources. The 
mere fact that the price of a security is rising causes them to buy, 
a kind of herd action which operates cumulatively and drives prices 
higher still. When the reaction comes and price falls, the limited 
extent of their resources, reinforced perhaps by a touch of panic, 
compels them to sell, and general selling drives price rapidly down- 
ward, perhaps far below its true level. Such operations may in- 
crease the activity of the market in the same way as large numbers 
do, but their influence on price is disastrous, and their net effect is 
undoubtedly to lower the efficiency of the market. In sharp 
contrast are the operations of Trust companies, financiers and other 
parties with an intimate knowledge of securities, and the resources 
which enable them to retain their holdings of a stock during a 
period when its value may be unduly depressed. The operations 
of parties of this kind contribute directly to the efficiency of the 
market ; for, by their willingness to buy securities when their 
prices are unreasonably depressed, and to sell securities when their 
prices are unreasonably raised, they increase the power of the 
market to resist pressure of buying and selling which is unjustified 
by the facts of the situation, and to maintain prices at levels more 
nearly approaching investment values. 

Finally, there is the work of the jobber, acting in response to 
the public demand or on his own initiative ; through his hands all 
operations pass ; and on his ability and financial strength the 
efficiency of the market is largely dependent .M 

A minor influence affecting the work of the market is that of 


the supply of money. As is well known, very large sums are 
borrowed by the public mainly to finance their speculative opera- 
tions, that is to say, to enable them to buy and hold securities 
in anticipation of a rise in their values. This money is obtained 
partly by direct borrowing from the banks and other parties with 
disposable funds, partly from Stock Exchange firms who lend 
their own money and also money which they obtain from banking 
and other sources. The great scale on which their borrowing is 
undertaken is partially indicated by a return made in October 1914, 
which, it is believed, showed that at that date the loans outstanding 
in the hands of London Stock Exchange firms amounted to no less 
than £81 m. The volume of securities held by means of borrowed 
money no doubt varies widely from time to time, but it is clear that 
the average volume must be very large indeed. 

A rise in Bank rate or any other cause tending to contract 
the supplies of short -loan money necessarily curtails these opera- 
tions and depresses the prices of securities, while a change in the 
opposite direction gives a lift to market prices. The great insta- 
bility of rates on the London money market must then be reckoned 
as a cause, though not perhaps a very important one, tending to 
affect adversely the efiiciency of the London Stock Exchange. 

Before passing on to consider in more detail the influence of 
the speculator on the efficiency of the London Stock Exchange 
we must notice a secondary consequence of its work in increasing 
the marketabiUty of the securities in which it deals. This increased 
marketability strengthens the position of individual business men, 
for it enables them in time of emergency to borrow readily on the 
security of their investments ; and it strengthens the position of 
a country as a whole, for it enables the negotiable security to be used 
as a means of making international payments during periods of 
difficulty arising from such causes as an adverse balance of trade or 
the exaction of an indemnity. 


IN order to estimate the social importance of any productive 
operation it is necessary to make a distinction between that 
direct product from the sale of which the entrepreneur defrays 
his expenses of production, and those indirect effects, in- 
cidental to the operation, which fall upon society at large. These 
incidental effects associated with an undertaking may be good or 
bad ; on the one hand, the extension of a tramway system may 
increase the value of the land through which it runs ; on the other, 
the construction of a chemical factory may lower the rents of 
buildings in its neighbourhood. In so far as such effects do not 
enter into the calculations of the entrepreneur, they must be 
separately estimated and their value added to or deducted from 
his direct net contribution in order to find the social importance of 
his operation. 

In the operation of an ordinary business, let us say a parcels 
delivery company, it is easy to distinguish between the direct service 
of transport, from the sale of which the company draws its profit, 
and those incidental effects, important in social if not in individual 
accounting, which arise from the deteriorating influence of the 
occupation on the industrial capacity of the van-boys employed. 
In the operation of the speculator these various effects are far 
more obscure, and the essential nature of the operation is itself 
not readily distinguishable. It will be convenient, therefore, to 
apply to the work of the speculator those criteria by which the 
social importance of industrial operations generally may be esti- 
mated. By so doing we can bring this work under the general 
analysis of productive operations, distinguish the essential 
nature of the speculative service, i.e. its direct product, and make 
some estimate of the incidental effects which accompany the 

The view adopted here is that the direct product of a specu- 
lative operation, that is to say, the service which the speculator in 
effect sells to the public and from which he draws his profit, is an 
act of trading through time ; and that the most important in- 
direct effects incidental to this operation are (i) the effect which he 


produces on the level of prices, and (2) the deteriorating moral 
effect of the occupation on the parties concerned in it. 

These criteria will be examined in that order. As they stand 
they form a comparatively simple analysis. But the good and evil 
effects arising from speculative operations are intermingled very 
finely ; they vary within these main groups in accordance with 
minor causes ; and the distinction to which they seem to corre- 
spond most closely is that between the skilled and the unskilled 
speculator. The matter is therefore complicated a little further ; 
for each of these main criteria must be considered first in relation 
to the speculator who is able to some extent to anticipate the 
future, and secondly to the speculator whose operation is based 
rather on temperament than knowledge. 

Before taking up the main argument let us consider for a 
moment the environment in which the speculator operates. To do 
so involves a repetition of what has already been repeated ; but 
in so complicated a matter as this it is perhaps more inconvenient 
to make a simple reference to the argument of a previous chapter 
than to restate that argument briefly in a manner which brings out 
the points most essential to the present discussion. 

We are concerned primarily with speculative operations in the 
market for negotiable securities, a market which consists of two 
parts ; the first deals with the creation and sale of new securities 
and links capitalists and entrepreneurs ; the second deals with 
these securities at a later stage and consists simply of facilities 
by which these old securities are interchanged among capitalists. 

It may be noticed that in the first part of this market the 
speculator acts to some extent as an unpaid underwriter. He 
operates as a "stag," buying the shares of, let us say, a new joint- 
stock company in the hope of selling them at a profit at a later 
date. It is true, more especially when working with borrowed 
capital, that his prospective sales form an element of weakness in 
the market for these shares and may cause damaging fluctuations in 
their price ; and, indeed, special devices are sometimes adopted 
to exclude him from participation in new issues (cf. p. 198). 
Nevertheless, his initial purchases must in many cases yield a 
service to the market inasmuch as they enable the company to 
obtain more easily the capital which it is seeking. However, the 
point is an unimportant one and need not be pursued further. 
Henceforward we need to concern ourselves only with the work 
done by the speculator in connexion with the securities already 
issued to the public, i.e. to the old securities dealt with by the 
Stock Exchange. 

The work of this second part of the market, the Stock Exchange, 
consists simply in making securities more readily marketable. 


It gives rise, therefore, to a twofold economy. By facilitating the 
purchase of securities it tends to increase both saving and invest- 
ment, and consequently draws into the market increased quantities 
of the capital held by the pubUc. By faciUtating the sale of securi- 
ties it relieves capitalists who buy new issues from those risks which 
would otherwise arise from their inabiUty to recover their capital 
at a later date should they wish to do so ; in this case also, there- 
fore, it increases the quantity of capital available for production or 
other uses. The point to notice — ^the only point which this re- 
petition is intended to emphasize — ^is the fact that every increase 
in the efficiency of the Stock Exchange may be expressed objectively 
as an increased marketability of stocks and shares, as an additional 
utility imparted to these stocks and shares, which reacts on the 
supply of capital, lowering its costs of production and consequently 
its supply price. 

With this point in mind we may pass on to consider the direct 
product of the speculator. 


IF the operation of the speculator is to be brought into Hne 
with that of any other production process it is essential first 
to distinguish his net product, that is to say, the service which 
he produces and which society buys from him. 
It seems clear that the operation of the speculator is closely 
S5mimetrical with that of the trader, and that in each case it consists 
essentially in an act of transport. The typical work of the trader is 
to buy goods in one place, carry them (or the title to them) and sell 
them to people situated elsewhere. His operation consists essen- 
tially, therefore, in an act of transport between two points of space, 
bounded at one end by a purchase and at the other by a sale. 
Similarly, the typical undertaking of the speculator is to buy goods 
from people at one time, carry them and sell them to people at a 
later (or earlier) date. His operation may be said, therefore, to con- 
sist essentially in an act of transport between two points of time, 
terminated by a purchase or a sale. It is true that in the sale of 
options and in some transactions on the Produce Exchange, his 
work is narrowed down to the bearing of risk, and that in deliberate 
manipulation his operation is widened to include a calculated 
disturbance to prices ; but these instances need not prevent our 
adopting his typical operation as the basis of the argument. 

It does not follow that anyone who buj^ and sells between two 
points of place or time is by that fact a trader or speculator. That 
would be the case only if the purchase and sale were bound together 
in one operation undertaken for the purpose of profit. When, for 
example, a person buys railway stocks for the interest they yield 
him, holds them and finally sells, market language classes him as an 
investor. If, however, he had undertaken the operation in antici- 
pation of a profitable difference between the buying and seUing price, 
market language would usually class him as a speculator. It is 
not entirely satisfactory to let the distinction turn on a question 
of intention ; but such a course is, perhaps, better than its alter- 
natives. We may, therefore, define the speculator as one who carries 
between two points of time with a view to profiting from a price 

difference between the two exchanges bounding his operatioa 



This operation of carrying is the essential part of the speculator's 
work whether on a Produce, or a Stock, Exchange ; but the public 
advantage to which this operation gives rise appears in the two 
markets in a somewhat different form. When speculators on a 
Produce Exchange carry cotton during the interval between the 
dates of harvest and manufacture, they relieve farmers and manu- 
facturers of risks which these parties would otherwise have to bear 
themselves. They specialize in risk-bearing ; in effect, they sell their 
service to farmers and manufacturers in exchange for an anticipated 
price difference ; and they do so at a price which is less than that 
at which these parties are prepared to bear those risks themselves. 
The main advantage from their operations consists, therefore, in 
relieving the industry of risks arising from fluctuations in the 
price of its material. Identical operations carried out on the Stock 
Exchange yield an advantage which is most conveniently expressed 
in terms of an increased marketability of stocks and shares. 

The Stock Exchange, like any other market, is an arrangement 
for establishing business contact between buyers and sellers distant 
from one another. In a local market this contact is usually made 
by the personal attendance of parties wishing to buy and sell. 
But in a central market like the London Stock Exchange this business 
contact is established by operations carried out by intermediaries, 
the professional dealers in the market, who join loose ends, as it were. 
The trading operations carried out by these dealers link buyers and 
sellers separated by space ; their speculative operations link buyers 
and sellers separated by time. These two kinds of operations (in 
practice usually one) are the threads binding together a market 
extended in space and time ; they form the warp and weft of the 
market, the actual material of which it is composed. The direct 
effect of these operations is to enable people to buy and sell more 
readily and conveniently ; an effect which may be interpreted in 
terms of an increased marketability of securities ; in terms of a net 
gain in utility due to the transfer of securities from people who do 
not want them to people who do ; or, finally, in terms of a reduction 
in the supply price of capital. In the same way, therefore, as an 
Increased utility of goods is the expression of a manufacturing 
process, or of the work of the merchant who distributes them among 
people at different points in space, so the operation of the speculator 
on the Stock Exchange increases the marketability, and, therefore, 
adds to the utility of stocks and shares by facilitating their distri- 
bution among people at different points in time. We may, therefore, 
define his direct product in terms of this increased marketabiUty. 

It may be true that the operation of the speculator necessarily 
yields an advantage to the pubHc ; but it has still to be determined 
whether this is necessarily a net advantage, that is to say, whether 


or no the profit which he obtains is less than the value of his 

Take first the case of a trader who buys goods from A, carries 
them elsewhere and sells them to B, drawing a profit from the price 
difference between the two exchanges. If the exchanges at each 
end of his operation are free and intelligent, the facts show that the 
goods received by B were of greater value to him than the money 
he paid in exchange for them — ^greater, therefore, than the trader's 
profit plus the price for which A wilHngly parted with the goods. 
It follows, therefore, that the transfer of goods effected by the trader's 
operation necessarily increased their utiHty by an amount greater 
than his profit, i.e., that the operation necessarily yielded a net 
social benefit. 

It appears at first sight that the operation of the speculator, 
bounded at each end by a free sale, corresponds to that of the trader 
and accordingly must also yield a social benefit. The two kinds of 
operation are of course closely symmetrical, but the fact that the one 
involves an interval of space and the other an interval of time intro- 
duces a difference which is of great importance in determining 
whether or no the speculator's operation yields a net benefit to 

The essence of the matter lies in the fact that in the one case 
the value of the goods dealt in is fairly easy to estimate, and that in 
the other it is estimated only with great dif&culty. The trader is 
concerned primarily with the present value of goods. The party 
with whom he deals has no great difficulty in estimating their value 
in relation to his present wants. Ordinary knowledge and ordinary 
intelligence are usually sufficient to ensure that his exchange yields 
him a balance of advantage. The expert knowledge of the trader 
may give him some opportunity for deception and, in a few classes 
of goods, considerable opportunities ; but in general bargaining 
knowledge is sufficiently equal to ensure that each obtains an 
advantage from his deal. 

Contrast with this the position of the speculator. Inasmuch 
as he operates between the present and the future, it is essential 
that he should form some estimate of the future value of the goods 
in which he deals. If the speculator and the parties with whom he 
deals all have equally good knowledge of this future value, the 
speculator is in the same position as the trader, and it is in general 
impossible for him to draw a profit from his operation greater than 
the money value of the utility which it adds to the goods. 

In fact, however, ordinary knowledge and ordinary inteUigence 
are very inadequate in forming an estimate of this future value ; 
skill, experience and particularly inside knowledge wlQ often disclose 
prospective values very different from those suggested by ordinary 


knowledge ; and this special intelligence may be employed as a 
means of abstracting wealth from those who are less well informed. 

In order to bring out the point more clearly let us suppose that 
an official of a joint -stock company knows that his company is about 
to declare an exceptionally high dividend. This official can then 
operate as a skilled speculator ; he may buy shares in the company, 
wait until his special knowledge has become pubUc and then resell 
his shares at a prolBit. His operation yields an advantage to the 
general public ; for it has in effect brought together the party from 
whom he bought and the party to whom he sold, enabling them to 
deal with less difficulty and delay than would otherwise have been 
the case. Had the knowledge of these two parties been equal to 
that of the speculator, the payment which they made for this facility 
would in general necessarily have been less than the advantage they 
received. But in fact the superior knowledge of the speculator 
enabled him to abstract from them a profit out of any relation to 
the value of the service which he rendered. 

In general, when the exchanges constituting the framework of a 
production operation are free and intelligent, the operation neces- 
sarily jdelds a net economic contribution. In the operation of the 
speculator this natural safeguard breaks down owing to the difficulty 
of estimating the value of the commodity which is the subject of 
exchange. There is, therefore, no a priori assurance that the opera- 
tion jdelds a net advantage to society. The question can be 
answered only by reference to the facts — ^by determining in each case 
whether or no the speculator exercises bargaining knowledge superior 
to that of the party with whom he deals. 

In any market where speculative activity is unchecked, an evil 
which arises solely from unequal bargaining knowledge can be met 
only by redressing the inequality of knowledge on one side or the 
other. In fact, the organization of markets tends both to strengthen 
the position of the public and to weaken that of the market experts 
with whom, directly or indirectly, they deal. In the wholesale 
markets for such commodities as wool, tea or sugar, the expert know- 
ledge of sellers is neutraHzed by the employment of expert buyers. 
In more speculative markets where the public participate directly, 
the more effective safeguard is found in the latter condition — ^the 
condition in which the pressure of expert competition is engaged 
to force prices into conformity with the best -informed anticipations 
of the market ; as, for example, in an organized Produce Market the 
whole information at the disposal of the market is expressed from 
moment to moment in the price of the commodity. 

It must be noticed that the effect of competition in speculative 
price-making is of more than ordinary importance. Defective com- 
petition in trading operations rarely does more than diminish the net 


gain of utility which accrues to the public ; it may require the con» 
sumer to pay a higher price, but it cannot usually make him pay a 
price in excess of the utiUty to him of his purchase. Defective 
competition in speculative operations, on the other hand, may 
frequently result in this net gain being converted into a large net 

The manner in which this safeguard operates on the London 
Stock Exchange will be taken up in the following chapters. 


AS there is no a priori assurance that the profit of the 
skilled speculator is confined within the value of the 
service he suppHes, it becomes necessary to consider how 
far in fact the organization of the Stock Exchange 
protects the public from his depredations by limiting his power to 
profit by the exercise of superior bargaining knowledge. 

The general presumption that the superior knowledge of the 
skilled speculator enables him to exploit the public gives consider- 
able justification to the established prejudice against speculation. 
As, however, this prejudice — or at any rate a prejudice resting on 
this ground — does not extend to the work of the Jobber, whose 
operations are essentially speculative, it seems likely that the 
organization in which the Jobber works is such that it enables 
society to obtain the advantage of his speculative operations while 
preventing him from using his superior knowledge to obtain a pay- 
ment in excess of the value of his work. Let us then begin by 
examining the situation of the Jobber. 

The functions of the dealer on foreign markets are carried out 
on the London Stock Exchange by two distinct parties, the Broker 
and the Jobber or Dealer. The Broker is the expert agent of the 
public. His skill and experience enable him to advise clients with 
regard to the transactions which they undertake and to put his 
clients on equal bargaining terms with the Jobber in carrying out 
those transactions. He serves in effect as a kind of ring fence 
round the Jobbers, protecting the public from contact with danger- 
ous machinery — dangerous, of course, not from any moral weaknesses 
on the part of the Jobbers, but because the superior knowledge of 
the value of securities possessed by these experts would in many 
cases place the public at a disadvantage in deahng with them 
directly. The familiar operations of the " bucket shop " show how 
easily an unscrupulous dealer can take advantage of his superior 
knowledge of securities when dealing directly with the pubUc. 

The Jobbers, who form the majority of the members of the 
Stock Exchange, are not agents Uke the Brokers, but principals. 
They carry out the trading and speculative operations which actually 


constitute the market in securities. It is their business to buy or 
sell any negotiable security on demand and to " carry " during the 
interval which elapses before they are able to " undo " their deal 
by a further and contrary transaction with some other party. 
They constitute, therefore, the core and centre of the market ; and 
through their hands every transaction passes. 

It has already been stated, perhaps too frequently, that the 
direct service of every speculator on the Stock Exchange appears 
in the form of an increased marketabiUty of securities. This is 
most obvious in the case of the Jobber ; and the fact that this 
direct service is sold to the public like any other is also most obvious 
in his case, inasmuch as the price at which he sells this marketabihty 
is much more clearly defined than in the case of other speculative 

When a Jobber is asked by a Broker at what price he will deal 
in any particular security, he is usually prepared to quote two 
prices at one of which he is ready to sell, and at the other to buy, 
a re nable quantity of the security in question. The difference 
between those two prices, the Jobber's " turn," represents of course 
the price of his service, the payment which he requires for the trouble 
and risk involved in completing the first deal, in bearing the risk 
of fluctuation of price during the interval which elapses before he 
can undo his bargain and in completing the subsequent deal. The 
main question to be answered is whether the general circumstances 
surrounding the Jobber restrict the amount of this turn within 
the value of his service. But before taking up that question, 
something must be said as to the costs of the Jobber's service and 
the effect on these costs of general market conditions. 

The main cost of the Jobber's work must evidently be that of 
ucaUng with the risk of price fluctuation during the interval 
between his purchase and his sale. He may bear this risk 
or destroy it, in part at least, by anticipating the movement 
of prices. 

In an organized speculative market for such produce as wheat 
the work of forecasting the future course of prices is doubtless of 
great importance. The market is called upon to carry wheat for 
a considerable part of the period between harvest and consumption ; 
and the course of prices, apart from " comers " or " squeezes," 
depends mainly upon calculable data such as estimates of produc- 
tion and consumption. In consequence, professional operators will 
often set up elaborate arrangements for anticipating future prices, 
and the cost of undertaking risk becomes in a considerable degree 
the cost of destroying it. 

On the Stock Exchange the interval through which the Jobber 
is called upon to carry securities is of course far shorter ; and, at 


the same time, the influences governing price movements are less 
calculable. Nevertheless, the fact that each Jobber specializes 
in a narrow range of securities shows that his work does not consist 
merely in bearing risk but also in destroying it. 

The distinction is not, however, a particularly useful one. The 
main points of interest are the influences which determine the 
amount of risk falling on the Jobber during the interval which he 
is required to bridge. Evidently the more active the security in 
which he is asked to deal, the shorter is the interval during which 
he has to carry, and accordingly the closer the two prices he quotes 
and the smaller his turn. On the other hand, the more uncertain 
the fluctuation of prices which may occur during this interval, 
the wider the two prices he must quote and the larger his turn. 

The larger the amount of any kind of security dealt in, the more 
active, of course, is its market likely to be. But apart from this, 
the main influence narrowing the Jobber's interval must arise 
from the optimism and the pleasurable excitement of risk-bearing 
— ^that is to say, the pleasurable anticipation of profit which causes 
the amateur speculator to dabble in certain kinds of stocks and 
shares, thereby making an active market in them, and doing so in 
many cases for a very low payment, but more usually even at a 
positive loss. It is not suggested that either optimism or the 
pleasures of risk-bearing affect the seasoned Jobber directly. But 
they certainly affect him indirectly — inasmuch as they result in 
the amateur speculator gratuitously making an active market, 
which narrows the interval to be bridged by the Jobber and conse- 
quently reduces the amount of his turn. 

The effect of the operations of the amateur speculator on the 
size of the Jobber's turn is partly set off by the fact that amateur 
speculation may increase the uncertainty of price movements and 
consequently increase the risks falhng on the Jobber during the 
interval through which he carries. This " indirect " effect of 
speculation on prices is discussed in a later chapter and need not be 
considered here in any detail. Moreover, it seems tolerably certain 
that the influence of speculation by the pubhc is much more important 
in narrowing the interval through which the Jobber has to carry 
than in increasing the risk falling on him during that interval; 
i.e. that its net effect is to reduce the work to be done by the Jobber. 
However, there is no need to balance these two effects now ; to do 
so is to anticipate a more compHcated sum to be done in a later 
chapter. At the moment the conclusions required are these. 

The Jobber's costs depend on the length of the interval which 
he has to bridge and on the uncertainty of price movements during 
that interval. The length of this interval is reduced by the opera- 
tions of the speculating public ; and it may be noticed that the 


direct product of these operations appears, in the special circum- 
stances of the London Stock Exchange, in the form of a reduction 
in the Jobber's costs — in reducing the price at which he imparts 
marketabiUty to securities. The Jobber, reUeved in this way of 
part of his work, carries out the remainder in exchange for his 
*' turn." Finally, this turn plus the Broker's commission is the 
price which the public pay for the enormous advantages arising 
from the immediate marketability of securities. 

This outhne of the organization in which the Jobber works is 
a preUminary to deaUng with the question of whether this organiza- 
tion ensures that the Jobber's special knowledge of the commodity 
in which he deals is not employed to obtain a payment in excess 
of the value of the service which he renders. 

The organization permits no member of the public to deal 
direct with a Jobber. There must in every case be an inter- 
mediary, the Broker, one of whose functions is to act as an expert 
agent, buying and selling on behalf of the public, and enlisting the 
forces of competition in their protection. Not only, therefore, 
are the Jobbers in keen competition with one another, but this 
competition is quickened by the Broker, whose interests are those 
of his cHent. But the Jobber is more highly specialized than 
the Broker, and even this measure of protection may be insufficient. 
Accordingly, there is the further provision that before a Broker 
discloses himself as a buyer or seller of any security Jobbers most 
usually quote two prices, one at which they will buy and another 
at which they will sell a reasonable quantity of the security in 

The organization of the market, therefore, has a twofold effect. 
On the one side it increases the bargaining power of the public 
by providing for the intermediation of the Broker ; and this is 
supplemented by the pubUcation of a daily Official Price List 
and a vast amount of information issued by specialized financial 
journals. On the other hand, it provides for the keenest com- 
petition on the part of the Jobbers, and consequently compels 
them to quote prices which disclose their anticipations with regard 
to the movements of prices in the near future. The dealings of 
the Jobber with the public are, therefore, hedged about by the 
market with so many safeguards that it seems safe to conclude 
that the Jobber in the ordinary course of his business has little 
or no opportunity of employing his superior knowledge to extract 
a profit greater than the value of the service he renders. 

It must, however, be remembered that the organization of 
the London Stock Exchange is fixed by formal regulations laid 
down by its committee, and can be varied by individual members 
only within the limits imposed by those regulations. The value 


of an arrangement, therefore, by which every transaction passes 
through the hands of the Jobbers is affirmed by the opinion of a 
majority, and not by its maintaining itself against the continuous 
pressure of alternative methods. Accordingly, although it has 
been shown that the Jobber has little opportunity of employing 
superior bargaining knowledge to increase his profits, it cannot 
be definitely proved that this profit is necessarily less than the 
value of his service. It is conceivable, for example, that if the 
regulations maintaining the separate existence of Jobber and 
Broker were abolished, the costs of marketing might fall. On 
the whole, however, it seems to be a very safe conclusion that the 
operations of the Jobber 5deld a net advantage to society, and it is 
a matter of small surprise that these operations are rarely classed 
as examples in the account of the speculator's iniquities. 



IN the last chapter it was found that, owing to the organiza- 
tion of the market, the Jobber bargained on practically 
equal terms in his dealings with the public, and that conse- 
quently his profits were not unduly increased by the exercise 
of superior bargaining knowledge. In this chapter we have to 
consider to what extent other skilled speculators are able to obtain 
profits in excess of the value of their service by the use of superior 
knowledge in their dealings, through the Jobber, with other 
members of the public. 

The Jobber, though legally a principal, is economically an 
intermediary, and a complete transaction on the Stock Exchange 
includes both parts of the operation by which a security passes 
from the ownership of one member of the public, through the hands 
of the Jobber, into the ownership of another member of the public. 
As one of these members may himself be a speculator, the two 
real principals may have very unequal knowledge of the securities 
in which they are deaUng. The question under discussion, therefore, 
is that of the measure of protection which the organization of the 
market affords to the one party against the depredations of the 

It seems doubtful whether the information furnished by the 
press protects the public from itself to any great extent ; for 
that information is just as likely to afford special opportunities 
to the expert speculator as it is to make up deficiencies of know- 
ledge on the part of others. It may raise the general level of 
knowledge, but it seems unlikely to level differences in knowledge 
— still less in the abihty to apply it. The Broker is no doubt an 
important safeguard. Were the public to rely more upon his 
advice they would place themselves on something Uke equal terms 
with the expert with whom in effect they are dealing. 

Some measure of protection is undoubtedly given by the 
Jobbers through whose hands all transactions must pass. If, 
for example, some alert and speculatively incHned man of affairs 
endeavours to anticipate the public appreciation of some favour- 
able news by buying the stock affected by this news, he will often 


find that this favourable effect is already anticipated in the 
quotation of the Jobber ; or, in other words, that the alertness 
of the Jobber prevents him from employing his superior intelligence 
against the remote party from whom he would have bought that 
stock. But when we have subtracted, as it were, the knowledge 
of the Jobbers from the knowledge of well-informed speculators 
among the public, there will still remain to these speculators many 
opportunities of using their special knowledge for the purpose 
of transferring wealth from the public to themselves. 

The tale goes that the fortunes of the Rothschild family were 
founded by a successful operation in Consols based upon early 
intelligence of the results of the battle of Waterloo. The Roths- 
child who carried out this operation, having obtained the earliest 
news of the victory, bought large quantities of the stock, held it 
until the news became generally known, and then sold it at a hand- 
some profit. Apart from its effect on prices, the public gain from 
this operation consisted in the advantage which certain people 
obtained from rather greater facilities for selling their Consols, 
and from the similar advantage which another group of people 
enjoyed a few days later from somewhat greater facilities for 
buying. As, however, the former group of people sold a commodity 
of a value far greater than they imagined ; that is to say, as the 
exchanges bounding the speculative operations were vitiated by 
unequal knowledge, the public paid over to the speculator a price 
which was out of all proportion to the value of his service. The 
deal was in all essentials similar to that operation which is occas- 
sionally associated with the practice of lynch law, the operation, 
namely, of bu5dng a defective horse in a neighbourhood where 
his defect is common knowledge, and selling him in another 
neighbourhood where his defect is unknown. There is, it is true, 
this important difference between the two cases, that opinion 
would as generally condemn the one transaction as dishonest as 
it would regard the other as a fair example of business enterprise. 

The Rothschild transaction is a type of many which the 
intermediation of the Jobber fails to make innocuous. It seems 
to be true that deliberate manipulation by strong financial interests 
is of small importance on the London Stock Exchange. The 
following extract from Mr. Hartley Withers' Stocks and Shares 
(pages 291-2) may serve, therefore, as a text for discussing the 
typical effects of skilled speculation. " In fact, it may be said 
that this is the normal course of events in market movements 
that are accompanied by speculation^ — that speculators, generally 
of the professional and well-informed class, anticipate good or 
bad news by purchases or sales, and close their commitments 
when the good or bad news arrives and produces buying by 


investors or sales by holders, while at the same time there is often 
an aftermath of speculative buying in the case of good news, by 
members of the outside pubUc, which more often than not loses 
its money by coming in too late, or, in the expressive Doric of 
Throgmorton Street * gets landed at the top/ " 

The typical expert speculator may be taken, then, to be of " the 
professional and well-informed class." He accordingly includes 
the Jobber. But this fact need not invahdate the argument of the 
previous chapter ; for it seems quite reasonable to distinguish the 
Jobber in his ordinary work of making a market in response to the 
public demand to buy and sell, from the Jobber in his capacity 
as a skilled speculator initiating operations in the same way as any 
other party in possession of special knowledge. As the term 
" expert " speculator is used here to mean simply one who deals 
in the hght of special knowledge, the class must be taken to include 
that numerous body of people whose business or personal con- 
nexions with the management of joint-stock companies and with 
people of expert knowledge in particular securities enables them to 
obtain better or earlier information of the prospective movements 
of particular stocks than the outside pubUc. Many of these people 
are able to profit almost without effort merely by being in the 
swim. Many others, such as the management of Trust Companies 
and other well-informed speculative investors, may spend much 
time and trouble in deahng in securities whose prices, for some reason 
or other, are not in accordance with their prospects. But the 
special information, whether obtained by good fortune or hard 
work, serves equally as a means of abstracting wealth from others 
who are less well-informed. 

" When the good . . . news arrives and produces buying 
by investors . . ." — ^when this has been done, the real principals, 
the investing members of the outside public, have completed their 
indirect deals with one another. The transfer of the securities from 
the one to the other has been faciUtated by the action of the skilled 
speculator, for his operations have narrowed the Jobber's turn ; 
but in the course of this transfer he has abstracted a large share of 
the price difference, and his profit will be out of any relation to the 
services he has rendered. Apart from its effect on prices, special 
information employed in this way has no social value. 

Again, if there is "an aftermath of speculative buying " by the 
public by which the value of the securities is forced above their 
investment value, the expert speculator who is in a position to 
appreciate this fact may undertake a bear operation which yields 
him a further profit at the expense of the pubhc. . In a single price 
wave, therefore, he is able to transfer wealth to himself both 
from the investing and from the speculating pubhc. But the 


social effects of this latter operation are not necessarily bad. When 
the ill-informed optimism of the public produces a speculative 
boom in some security and temporarily forces its price well above 
its investment value, the course of that price movement inevitably 
results in a considerable transfer of wealth among the parties who 
participate in it ; and if participation were confined to the specu- 
lative public a large number would be likely to make considerable 
profits and consequently to be encouraged to take part in further 
operations of a similar character. The participation of the expert 
speculator is likely to diminish this encouragement by enabling 
him to absorb a large part of these profits himself ; and the toll 
which he levies may be more than set off by the instruction he 
imparts. In so far as he encourages the boom his action is socially 
harmful ; but in so far as he taxes the dabbler in speculative 
securities, or operates as a bear and so checks the rise in prices, his 
action may be socially beneficial. 

Apart, therefore, from the expert initiation or encouragement 
of booms, the superior intelligence against which protection is 
especially required is that of the speculators who are able to antici- 
pate movements in the investment values of securities. It is 
clear that the value of items of inside information which are con- 
fined to only a few parties cannot be eliminated by the pressure of 
their mutual competition. Nevertheless, the presence in the market 
of other alert and experienced speculators, in particular the 
Jobbers, must do a great deal to ensure that the operations in 
which it is sought to make this exclusive information effective for 
profit serve also to publish it in the market. 

The employment in this way of inside information is, of course, 
limited to some extent by the general sense of the community. A 
general sense of what is right and proper prevents a pohtician from 
using on the Stock Exchange special information obtained by virtue 
of his office ; and the same feeling, reinforced by other considera- 
tions, deters the directors and officials of joint-stock companies from 
speculating in the shares of their own or allied companies. But 
while the use of inside information obtained by virtue of official 
position is usually condemned, the employment on the Stock 
Exchange of similar information obtained in other ways conforms 
so closely to ordinary business operations that the moral sense of 
the community condemns the one no more than the other. 

There is no need, however, to deal with the employment of 
superior bargaining knowledge as a question of morals. It is 
sufficient for present purposes to consider its effects on the well- 
being of society. In these terms the conclusion of the present 
chapter is platitudinous enough. It is that there are considerable 
numbers of expert speculators who, in effect, deal through the 


Jobber with less well-informed members of the public and use their 
superior knowledge of securities or of the moods of the public to 
transfer wealth from these other parties to themselves. The 
unskilled speculators and investors with whom they deal obtain 
some protection from the Jobber, and can, if they choose, obtain 
almost complete protection by acting only on the advice of a com- 
petent Broker ; but the facts show that they do not avail themselves 
fully of this safeguard. In so far as the expert speculator levies his 
toll from the speculating public without still further exciting their 
activities his operations are not without some advantage to society, 
for they tend to discourage the pubUc from a form of enterprise 
which can rarely yield any net social advantage. In so far as 
he deals with investors he takes from them the advantage of price 
movements without giving any adequate return, and the direct 
effect of his operations is a net social loss. 


THE previous chapters have been wholly concerned with 
the direct effect of the speculator's operations in reducing 
the cost of buying and selling securities. The present 
chapter deals with the indirect effects of his operations 
on their price level. 

The influence of speculative operations on price is indirect in 
the sense that its good and evil consequences are not taken into 
account by the speculator ; they fall not on him but on society at 
large. The regulation of price is not a matter which society en- 
trusts to the speculator by making his profit dependent on its 
performance. It is true that Governments and other bodies 
occasionally make speculative purchases with the direct object of 
maintaining the prices of the securities they have issued ; and, 
further, that prices may be deliberately manipulated, by the spread 
of false rumours and in other ways, as a necessary prelude to pro- 
fitable speculative transactions. In such cases the action on prices 
is an essential part of the speculative operation and must be so 
included. In the typical case, however, the operation of the specu- 
lator — that from which he draws his profit — ^is simply an act of 
trading between the two prices. The good or evil effects of this 
operation on these prices are incidental consequences of this act — 
consequences closely analogous to the good or evil effects of a 
manufacturing process on the workpeople engaged in it. Neither 
the speculator nor the manufacturer is paid for producing these 
incidental results ; accordingly these results must be separately 
estimated and added to or subtracted from the value of the 
direct product. 

In any community where economic activities are adjusted by 
individual initiative and not by any central controlling authority, 
price has important functions ; for it serves as an index which 
regulates on the one hand the output, and on the other, the con- 
sumption of particular commodities. " True " prices (cf. p. 226), 
therefore, co-ordinate production and consumption ; prices varying 
from the true level lead to maladjustment and waste. In the 

Securities Market industrial stock is the commodity with which we 



are concerned ; and the parties corresponding to the producer 
and consumer are those who issue this stock and those who buy 
and hold the shares. It may be expected then that the maintenance 
of true prices for industrial stocks will have some influence in 
regulating on the one hand the output of business undertakings and 
on the other the absorption of their stocks by the pubUc. Further, 
as the remote effect of true prices increases the utiUty of, say, 
wheat to the consumer, so, it may be expected, will true prices for 
securities increase their utility to the investor. Without arguing 
the matter in detail it seems reasonable to make the following 
three statements : 

Speculative activity which drives price considerably above 
investment value unduly encourages the issue and 
purchase of new securities and accordingly produces 
waste ; 
Speculative activity which forces price away from invest- 
ment value increases the risks both of buying and holding 
securities ; 
Speculative activity which makes prices more variable 
probably repels the investor by increasing his risks, but 
is likely to attract further speculators ; 
and to use these as criteria for estimating the good and bad effects 
of speculation on prices. 

Let us now bring these conceptions into touch with the actual 
facts of the market. The Stock Exchange, though a single market 
in so far as it facilitates the exchange of money and securities, is 
more properly regarded as a group of interconnected markets 
(cf. p. 223) ; the actual number being reckoned as the number of 
groups of speciahzed Jobbers or as the number of different kinds of 
securities ; the latter being probably the more convenient for the 
present argument. Each market has a large measure of independ- 
ence determined by the characteristics of the security itself and the 
circumstances and temperament of the particular part of the public 
who deal in it. At the one extreme is the market in a security 
whose value is naturally variable or indefinite ; here is the natural 
home of the unskilled speculator. At the other extreme is the 
market for the soUd investment stock which the public enters only 
as an investor. Between the two is an indefinite range of markets 
in which the pubUc appear in characters intermediate between those 
of the speculator and the investor. 

There are two circumstances which are Hkely to affect specu- 
lative price-making in these markets. In the first place, it seems 
probable that the amount of speculation on the London Stock 
Exchange is increased by the comparatively long interval between 
settlement days ; inasmuch as the speculator is enabled to operate 


during this fortnight without being called upon to hand over either 
securities or capital.92 It is true that on the New York Stock 
Exchange where daily settlements are the general rule, speculative 
activity is even greater than in London ; but this objection is far 
from conclusive, as the shorter interval for settlement is evidently 
only one of many differences between the two markets. The in- 
fluence of shorter settlements on the New York market in curtaiUng 
speculative activity is no doubt largely neutralized by exceptional 
facihties for " carrying over " due to the lack of a developed dis- 
count market and the consequent tendency of banks to employ 
their short money mainly in financing Stock Exchange operations. 
The huge scale on which such facilities are provided in London is 
suggested by the fact, already noticed, that in October 1914 the 
London Stock Exchange owed outside financial institutions (no doubt 
mainly the banks) no less than ;f8i m. Nevertheless, it seems 
to be only reasonable to suppose that a considerable number of 
the speculative public who now dabble in gold mines or rubber 
shares would cease to do so if the settlement were a daily one and 
they found it necessary to support each speculative purchase by 
borrowing from a Banker or Broker. 

But whether or no the amount of speculation is much increased 
by the practice of a fortnightly settlement there can be little doubt 
that the effect of speculation on prices is considerably influenced 
by the fact that the public, by acting mainly on one side of the 
market, disturb the balance of power as between the bulls and the 

The available quantity of any security or of any kind of produce 
is definitely limited, whereas the available quantity of money, 
against which this security or produce is being traded, is practi- 
cally unlimited. It follows, therefore, that a person who sells in 
anticipation of a fall in prices runs much greater risks of being 
** squeezed " than the person who buys in anticipation of a rise ; 
for the " bear," when he sells, contracts to deliver part of a limited 
supply which may be unavailable when he comes to buy, whereas 
the " bull " contracts to deliver money which is practically always 
available at a price. The fundamental facts of the market, there- 
fore, already give the bull a predominance in the market, and this 
predominance is reinforced by the persistent habit of the pubHc of 
operating mainly on the bull side. This inequality is met in part 
on Produce Markets by allowing sellers to deliver other grades of 
produce than that in which they trade, at a fixed difference in price. 
But Mr. Brace, writing of the American market in his book on 
Organized Speculation, gives it as his opinion that, in spite of this 
device of increasing the number of grades of wheat which are a good 
dehvery, the bull side of the market is distinctly stronger than 


the bear. The bears, he thinks, are able occasionally to force prices 
down to what one may call the " true " value of the wheat ; but, 
he says, this level is the minimum, the base from which prices are 
continually being forced upwards by the bulls. The unequal 
forces on the two sides of the markets result, therefore, in average 
prices being markedly higher than would be justified by statistics 
of production and consumption. If this result occurs in a market 
where the bears have such a vast supply from which to make de- 
livery it seems hkely that the same cause acts even more strongly 
on the Stock Exchange where the amount of any one security is 
strictly limited. It seems, at any rate, to be a safe inference that 
the average prices of speculative securities are maintained at a level 
appreciably higher than their investment values. 

The general circumstances of the market are such then that the 
amount of pubUc speculation is probably increased by a fortnightly 
rather than a daily settlement, and is certainly increased by the ease 
with which capital may be borrowed for carry-over purposes both 
from Stock Exchange firms and directly from the banks ; and that 
the effect of this speculation by the pubHc is, in general, to drive the 
prices of speculative securities above, and often far above, their 
investment values. 

These general market influences affect mainly the inexpert 
speculating public ; a sharp distinction is necessary between the 
effect on prices of this kind of speculation and that resulting from 
the operations of the skilled speculator. The skilled speculators, 
as the term is used here, are those who have better knowledge of the 
future price movements of securities than the general pubUc with 
whom, through the Jobber, they deal. Now in the greater part of 
the investment markets, that is to say, in the markets for securities 
not Uable to speculative booming by the unskilled public, these price 
movements are determined mainly by changes in investment values. 
Accordingly the opportimity for profitable speculative dealings in 
these markets Ues in buU or bear operations designed to anticipate 
changes in investment values ; and such operations carried out in 
the light of superior knowledge necessarily tend to move the prices 
of securities into closer approximation to these investment values. 
It seems quite safe to conclude, therefore, that the effect on price of 
skilled speculation in the investment markets yields a net advantage 
to society ; for though these operations may increase the variabihty 
of prices they maintain them at a truer level, and their net effect 
must almost certainly be to reduce the investor's risks both in buy- 
ing and in holding securities. The total effect of this kind is very 
considerable, for very large amounts of capital are controlled by 
experts and shifted from one security to another in accordance 
with anticipated changes in their investment values. Trust 


Companies alone control more than £ioo m. ; and there must be 
added to this the investments of banks and Insurance Companies, 
the capital owned or borrowed by professional and well-informed 
speculators in close touch with the market, and even that of the 
speculative investor who, with the assistance of his Broker, buys 
securities whose values are temporarily depressed by extraneous 
circumstances. This continuous movement of capital under expert 
speculative control may 3deld to those who move it profits much in 
excess of the direct value of their operations in increasing the market- 
ability of securities. But its incidental effects on price must result 
in a very substantial advantage to society, by reducing the risks 
of investment and consequently lowering the supply price of 

Turn now to a market in which prices are determined mainly by 
the unskilled speculative public and where the operations of the 
skilled speculator are based rather on his anticipations with regard 
to the moods of the public than on prospective changes in the 
investment value of the security. This may be the market for the 
shares of a copper mine or a rubber company or the ordinary shares 
of an industrial enterprise on which are concentrated most of the 
risks of the undertaking. Suppose that some favourable report is 
published dealing, let us say, with a prospective increase in the 
demand for copper, and that professional speculators on the Stock 
Exchange xmdertake bull operations in copper shares with a view 
to giving prices a lift, bringing in the public and unloading their 
shares later at a handsome profit. In these circumstances it may 
quite well happen that the public come in heavily and drive the price 
of the shares temporarily to a price far above their investment 
value. The rising price index acts on copper shares as on any 
other commodity ; it operates as a sign to the company promoter, 
calling into being a number of new business undertakings for the 
production of copper, and as a sign to the public to buy the shares 
of these undertakings as they are issued. Moreover, it is likely to 
call into being not only an excessive number of companies for pro- 
ducing copper but also a number of companies whose main purpose 
is to transfer wealth from the public to the promoters. The end of 
the boom is probably anticipated by profitable bear operations on 
the part of the skilled speculator ; and as, in the general collapse, 
the price of the shares of sound companies will almost certainly fall 
below their true value, he has yet another opportunity to profit at 
the expense of the inexpert public. The net result of this outburst 
on the part of the speculative public is likely then to be that a large 
amount of wealth has been transferred from them to the skilled 
speculator and the company promoter ; that the copper-producing 
industry has been disorganized ; and that the public are left in 


possession of large numbers of copper shares which will yield them 
perhaps an average of less than i per cent on their capital. 

It does not follow that the public should not participate in these 
speculative markets ; on the contrary, it is clearly in the social 
interest that capital should be supplied to risky ventures in order that 
industrial experiments may be initiated and industrial opportunities 
developed. But the capital should be supplied in conformity with 
prospective yield. A risky venture has an investment value of a 
kind. It offers a set of prospective net returns ranging perhaps from 
a large negative to a large positive yield. If the actuarial value of 
that set of returns is not less than the net rate of interest plus a 
reasonable payment for the uncertainty of the yield, then that 
venture has a social claim to be supplied with capital ; that is to say, 
it would be to the economic advantage of society as a whole that the 
venture should be provided with the capital it requires. In point 
of fact, however, the unskilled investing public have neither the 
power nor the will to make a good estimate of the investment value 
of such a security. A wide range of prospective net returns is more 
Ukely to touch their imagination, make them highly susceptible to 
suggestion and lead to herd action which results in an overvaluation 
of the security accompanied by wildly fluctuating prices. Conse- 
quently production is periodically disorganized ; the industry is 
supplied with capital in excess of its social claim ; and, the organiza- 
tion of the market being what it is, a large part of the capital 
provided by the public is transferred into the hands of the company 
promoter and the skilled speculator. In the highly speculative mar- 
kets, therefore, the influence of the unskilled speculator is to force 
prices away from investment values and by increasing their varia- 
bihty to encourage further speculation, this twofold effect leading 
to heavy social waste. In so far as his operations extend to securities 
which are more in the nature of investments, his influence is in a 
similar direction. His lack of knowledge and his financial weakness 
both tend to increase the uncertainty and the variability of prices, 
and both, consequently, tend to increase the risks of the investing 
pubHc. The main conclusion of this chapter may be summed up in 
four statements. They deal only with the speculator's influence on 
the price of securities. 

1. Speculative operations in which special knowledge is em- 
ployed to anticipate changes in the investment values of securities 
not subject to speculative booms estabUsh a truer course of prices 
and consequently increase the efficiency of the market. 

2. Skilled speculative operations in markets for securities of 
variable and uncertain value are ambiguous in their effects. On 
the one hand, they tend definitely to distort prices when they are 
employed to initiate or foster a speculative boom ; on the other 


hand, they correct the false valuations of the pubUc when they 
are employed, for example, in bear sales during a boom, or in the 
purchase of undervalued securities when the boom has collapsed. 

3. Unskilled speculative operations carried out independently 
in the investment markets cannot in general improve prices ; but 
they are likely to increase their variability and consequently to 
lower the efi&ciency of the market. 

4. Unskilled speculative operations, governed largely by ir- 
rational herd impulses, produce effects on prices which are wholly 
bad and lead to heavy social waste. 


JUST as in Adam Smith's time the use of the jack-plane 
injured the physical health of the carpenter, so speculation 
tends to exercise a destructive influence upon the capacities 
of those who engage in it. And as in neither case would 
earnings contain an amortization fund to compensate for the 
damage done, the injury is a net evil and must be separately esti- 
mated in any account of the social importance of the occupation. 

In the case of speculation it is evidently much easier to describe 
these destructive effects than to evaluate them. To the more 
hard-headed and self-regulating people who deal with the un- 
certainties of the future in a business spirit, the possibiUty of 
drawing a profit from the changing values of securities may come 
only as a pleasant stimulus. It would be rather absurd, for 
example, to suggest that the cautious speculative investor or the 
seasoned jobber in the course of his normal business suffered any 
moral damage from his occupation. 

But among the inexpert speculating pubUc there must be many 
on whom the relatively large and easy losses and gains of specula- 
tion exercise a definitely demoralizing effect ; for the practice of 
confiding material welfare to the caprices of an unknown future 
must tend inevitably to destroy those pedestrian quaHties of 
persevering, reasoned industry which have a high practical value 
as the world is now ordered. To many, no doubt, speculation 
brings its own antidote in the form of large losses to be set against 
trifling gains ; but in other cases these losses serve only as an 
incentive to further speculation until the fever is at last reduced 
in the calm of the Bankruptcy Court. The deteriorating effects 
of speculation may in particular cases be as severe, but they are 
evidently not nearly so widely spread as the closely analogous 
influence of alcohol. They could be better expressed in the form 
of biographies than as a generaUzation. Nevertheless, the general 
conclusion may be expressed that this incidental effect of specula- 
tion constitutes an evil cf appreciable importance ; it introduces 
uncertainty on so large a scale as to weaken that connexion between 


" conduct and consequence " which forms the basis of rational 

The main conclusions of this long argument may now be brought 

The typical process of manufacture or trade consists of an 
operation confined within a set of exchanges ; its product consists 
of the utility added to the goods by this operation ; its payment 
is drawn from the price differences between the set of purchases 
and the set of sales. So long as the exchanges bounding this 
operation are free and intelligent the utility of the product must 
exceed the price at which it is sold. In such circumstances, there- 
fore, the act of production jdelds a net economic contribution ; but 
it may set up incidental effects which must also be taken into 
account before its social importance can be estimated. 

The typical speculative operation, similarly, lies between a 
purchase and a sale ; its product consists in carrjdng from a party 
who wishes to sell to a party who wishes to buy. This product 
appears on the Produce Exchanges mainly a service of carr3ring, on 
the Stock Exchange in the form of an increased marketability of 
securities. The payment for this product is derived from a price 
difference between the purchase and the sale ; and this payment 
must be less than the utility of the product so long as the exchanges 
are free and intelligent. 

In fact, however, there is no assurance that each of the parties 
to the exchanges bounding a speculative operation have adequate 
knowledge of the commodity in which they are dealing ; for it is a 
matter of extreme difi&culty to form a true estimate of the market 
value of a commodity whose price fluctuates with the imperfectly 
foreseen changes of the future. This uncertainty in the value of 
commodities is the source from which all the evils of speculation 
arise. On the London Stock Exchange its effect, on the one 
hand, is to enable the skilled speculator to abstract a part of the 
value of the security from the party with whom he is dealing, and 
so to obtain a profit in excess of the value of his services. 
On the other hand, it lures the unskilled speculator into operations 
which yield him little or no profit and which have incidental results 
productive of great social waste. In any attempt to estimate the 
social importance of speculative operations it seems essential to 
follow this distinction and to deal separately with the social 
effects of skilled and unskilled speculation. 

The expert speculator or speculative investor has, by definition, 
bargaining knowledge superior to the party with whom he deals. 
He may obtain this superior knowledge merely by his good fortune 
in having access to inside information, or he may obtain it by the 
exercise of special skiU g^nd experience ; but, whatever the source. 


he can employ it to transfer wealth to himself from the less well- 
informed public. In the one case, this additional profit is a kind of 
rent of position ; in the other, it consists of earnings of management 
comparable with those obtained from ordinary business ; but in 
neither case is there any social return proportionate to this addi- 
tional profit. Its existence draws into the occupation business 
abiUty and energy which could be employed elsewhere with greater 
advantage to society. 

The profitable employment of this superior bargaining know- 
ledge is limited in two ways. In the first place, the pubUc may, 
and to some extent do, act upon the advice of skilled brokers, and so 
bring their bargaining knowledge more into equality with that of 
the expert with whom, in effect, they are deaUng. In the second 
place, the alertness of other experts in the market, especially the 
Jobber, greatly limits the scope of the operations which can be 
profitably undertaken in the hght of any well-founded anticipa- 
tion. The Jobbers, for example, would be Ukely to scent this 
anticipation at an early stage of the operations, and the consequent 
change in their quotations would protect the pubUc from further 

In spite of these safeguards, however, it is clear that society has 
no a priori assurance that the profit of skilled speculators as a whole 
is less than the utiHty of their product, and, indeed, there is little 
doubt that, by the use of superior bargaining knowledge, these 
speculators can obtain a return often greatly in excess of the profit 
appropriate to their operations. The presence of these abnormal 
profits do not, however, prove that these operations, in their total 
effect, do not yield a net social gain. To answer that question, it 
is necessary to balance three things : first, the value of the opera- 
tions in increasing the marketability of securities ; second, the 
total profit yielded by them, or, alternatively, the excess profit 
obtained by the exercise of superior knowledge ; and, third, the 
importance of the incidental effects of these operations on the 
prices of securities and the characters of the pubUc. 

Let us begin with what may be vaguely described as the invest- 
ment markets and deal first with the Jobber in the ordinary course 
of his business. The Jobber is both trader and speculator ; as 
speculator he brings into business contact buyers and sellers separated 
by time. In the absence of this contact, the pubUc could buy 
securities — and, what is more important, they could seU securities 
— only if there were already in the market some other party ready 
to deal in a contrary direction ; or, alternatively, they could buy 
and sell only by offering to deal at a price so unfavourable to them- 
selves as to attract some other party into the market. The important 
influence which such a condition would exert in checking the supply 


of capital against negotiable securities is the measure of the value 
of the Jobber's services. When account is taken of the fact that 
the price of this service, the Jobber's turn, is forced down by 
mutual competition stimulated by the Brokers, it seems safe to 
conclude on these grounds alone that the Jobber's operations in 
making a market yield a large net contribution to society. 

In the case of other expert speculative operations carried out 
in the light of superior information (and including those similarly 
undertaken by the Jobbers) the net result is less clear. The direct 
effect of these operations is to reduce the Jobber's turn. But 
such speculators are, as it were, visitors rather than residents, and 
operations which they carry out on their own initiative are less 
important in their effects upon the marketability of securities than 
the ordinary operations of the Jobber carried out in response to 
the demands of the public. Nevertheless, these operations definitely 
reduce the price at which the public buy and sell securities, and 
to this direct contribution must be added their important incidental 
effects in estabHshing and maintaining a truer level of prices. Both 
these effects may be expressed in terms of a reduction in the supply 
price of capital. Whether this twofold economy is worth the price 
which the public pay over to the skilled speculator in the form of 
profits is a question which few people could answer with confidence. 
It must, however, be remembered that the acquisition of a good 
deal of these excess profits, particularly those due to the mere 
possession of inside information, does not involve any real cost, 
and is, therefore, only a transfer of wealth which leaves society 
as a whole as rich as before. When allowance is made for this 
fact it seems to be a reasonable conclusion that the operations of 
skilled speculators in the investment markets yield a net advantage 
to society. 

Their operations in the markets for securities of highly variable 
and uncertain value are most conveniently dealt with in conjunction 
with those of the unskilled speculator. 

In the social interest the very uncertain value of the securities 
in the speculative markets should call in capitalists able to make a 
calm and rational estimate of their worth and wilHng to buy and 
hold them at a price level at which their prospective net returns 
offered a high but reasonable yield. In fact, however, the naturally 
variable values of these securities have the contrary effect ; for 
they attract into the market mainly the unskilled speculative 
public who have no qualifications for handling such difficult material 
— ^still less the ability to contend successfully with the skilled 
speculators whom they find there. 

The speculative operations carried out in this market result, 
as in others, in reducing the Jobber's turn. It is difficult, however. 


to see that any appreciable social advantage arises from the in- 
creased marketabihty of these securities, for its main effect can 
be only to encourage speculative activity still more. Even in the 
investment markets the direct effect of the participation of the 
unskilled speculator is of doubtful social value, for although 
he reduces the Jobber's turn he does so at a heavy cost to 

The definition of the unskilled speculator shows that the effect 
of his operations in either the investment or the speculative markets 
cannot, on the whole, improve prices, but almost certainly distorts 
them and increases their variabiHty. But his lack of adequate 
knowledge is perhaps less important in this respect than his 
temperament ; for susceptibihty to the suggestion of rising prices 
leads to collective action on the bull side of the markets and 
consequently to price booms which result in a disturbance of 
production and heavy social waste. He may, it is true, enjoy 
the excitement of the game, but this is probably counterbal- 
anced, in social accounting, by the deteriorating effects which 
accompany it. 

The operations of the skilled speculator in these markets enable 
him to transfer wealth from the pubUc to himself, a result which 
can hardly be reckoned as an evil — ^not, at any rate, so far as it 
serves to estabUsh the reputation of the speculative market as 
a place of danger to be entered with caution and misgiving. Their 
effects on price are ambiguous, for while they may at times be 
designed to initiate or foster a boom, they serve at other times to 
bring prices more nearly into conformity with investment values. 
If no clear conclusion can be formed as to the net effect of the 
expert speculator's operations in these markets, it at least seems 
clear that the participation of the unskilled speculator results in 
a clear social loss. 

We have then the final conclusions that the Jobber certainly, 
and the skilled speculators almost certainly, make a net con- 
tribution to economic welfare ; and that the participation of 
the unskilled speculator is probably harmful in the investment 
markets and certainly harmful in those for highly speculative 

These conclusions apply only to the London Stock Exchange ; 
for they are based only in part on effects which necessarily result 
from speculative operations ; they depend also upon questions of 
fact, such as the organization and constitution of the market, in 
particular upon the knowledge and temperament of those who 
speculate in its securities, and the presence or absence of deliberate 
manipulation. They cannot, therefore, be extended even to other 
Stock Exchanges ; still less to the Produce Markets, where the 


effects, though similar in kind, differ in relative proportions ; and, 
least of all, to speculative operations in such property as land, 
where bear operations are impossible and price exercises no 
important function in the regulation of production and con- 


IN their passage from the soil to the consumer goods pass 
through the hands of a series of owners, creating as they 
pass a train of debts, a series of trade credits. It is with 
the significance of these debts that we are now concerned. 
In order to form any estimate of the volume of this great 
chain of debts outstanding at any time we should need to know 
the size, the number and the length, as it were, of these Hnks : 
that is to say, the value of goods at each stage of production, the 
number of owners through whose hands they passed and the 
length of the debts created between these successive owners. 
In fact, knowledge falls far short of this. We know that the final 
value of goods consumed in the United Kingdom in 1907 exceeded 
£1700 m. ; but the facts are so extremely complex, the methods 
of selling vary so much at different stages in the same trade and 
at corresponding stages in different trades, that even those in 
the best position to judge can form no estimate of the size of the 
other two factors by which this figure should be multiplied in 
order to obtain the outstanding volume of trade debts. 

The variety of selling methods within a single industry, and 
the consequent differences in the volume of trade credit engendered 
at each stage, may be illustrated by tracing briefly the movement 
of wool from the farm to the consumer. As the English farmer 
turns over his capital slowly, and may sometimes need to wait so 
long as two years before it is recovered in cash, he frequently 
takes credit extending to six or even twelve months from the 
dealers who supply him with fertilizers, feeding-stuffs and similar 
materials. The wool which forms one of his many products, he 
may in exceptional circumstances sell in advance ; but more 
usually he will dispose of it at a local auction on terms similar 
to those on which colonial wools are sold in London : namely, 
for payment in cash within a few days. As few spinners care 
to lock up their capital in heavy purchases, or are able to foretell 
the grades they will require during the course of the year, this 
wool is likely to pass into the hands of the merchant, the top- 
maker, who carries varied stocks of wool, combs it into tops, and 



enables spinners to draw from him their particular grades as and 
when they need them. The merchant sells these tops for pay- 
ment customarily within fourteen days ; less usually, he grants 
credit against four or six months* bills to spinners of sound reputa- 
tion but limited available capital. Between spinner and weaver, 
in contrast to the conditions prevailing in the cotton industry, 
there is no regular merchant class ; yarn is sold for payment, 
within one or two months. Piece goods, the product of the 
manufacturer, may be marketed in a variety of ways : they may 
be sold to wholesale clothiers, commonly for payment within a 
week, but not unusually on credit varying from one to four 
months ; to large miscellaneous retail dealers ; to shippers, 
usually for payment within one month; or to merchant houses, 
sometimes on long credit where the merchant has to wait for 
payment from a tailor, frequently on terms such that spring goods 
delivered September to February are paid for in the following 
April. ^3 It would seem, however, that this seasonal method of 
payment is now being abandoned ; for, according to the Wool 
Year-Book, 1917, the standard terms for the sale of cloth provide 
for 4 per cent discount if the goods are paid for by the loth of the 
month following dispatch, 2J per cent discount if paid for four 
months later, and an interest charge of 7 per cent if payment is 
made in bills beyond that date. In pre-war days, the customary 
terms on which piece goods passing through the merchants' hands 
were sold to retailers seem to have been 3^ per cent discount if 
payment was made by the ist of the following month and net 
prices if paid for within three months. To what extent these 
credit facilities are actually exercised little is known ; but Mr. 
Abbott notes : "... it has been observed in a typical wholesale 
house, that only a comparatively insignificant percentage of the 
accounts were paid so promptly as to secure the best discount, 
while 25 per cent of these were not entitled to any discount at 
all, though the majority of this latter class were quite solvent." ^4 
There remains the final link in the chain — that connecting re- 
tailers with the public. It is clearly impossible to form any 
estimate of the volume of trade credit engendered at this point, 
but it may be noticed that in the opinion of Mr. Abbott " the 
habit of credit -buying is slowly decaying, and the practice of the 
stores and retail businesses encourages the growth of ready-money 
payments, and consequently accelerates this decay, a most de- 
sirable consummation, since in retail trade the credit system is 
an evil both to shopkeeper and consumer.*' 

This rough indication of the train of debts originating in the 
movements of wool through its various stages of production 
suggests that their total volume is considerably less than might 


naturally have been expected. But it shows the great complexity 
and obscurity of the matter with which we are dealing : it shows 
how numerous are the points at which these debts may arise, 
how the conditions of credit vary not only between one point 
and another but between the different classes of purchasers at 
each point ; and how readily the practice of paying cash or taking 
credit may vary with changes in the organization of a trade and 
with changes in the financial situation of either sellers or buyers. 
The complexity of the matter extends further still ; for this, or 
indeed any other trade, cannot be taken as representative of con- 
ditions as a whole. 

Consider, for example, the conditions in constructional trades 
where the manufacturer's product is sold directly to the consumer. 

In the Building trades, long credits seem to be unusual ; with 
the exception of timber, materials appear usually to be supplied 
to the builder for payment within a month. The terms on which 
the product is sold to the consumer must of course depend on 
whether the house is built on private contract or for speculative 
sale. The standard pre-war contract for London and other 
large centres provides that the builder shall recover 75-90 per cent 
of his invested capital at the end of two months, and that thereafter 
payment shall be made monthly. Accordingly the credit which 
he normally grants to the building owner is not large. In the 
case of working-class houses it is stated that 90 per cent have 
been built by private enterprise, mostly by private builders. 
According to the Housing (Financial Assistarce) Committee, 
'* The usual plan has been for the builder to purchase an Estate . . . 
and to build a few houses at a time. He has obtained temporary 
financial assistance from a bank, a solicitor, a builder's merchant, 
or a building society and has sold the houses as soon as possible 
after completion. It has been essential to the continuance of 
-his business that he should have a ready sale." ^^ 

These two different methods of sale are found also in the 
Shipbuilding trades. " The marketing of ships and marine 
engines," say the Committee on Shipping and Shipbuilding, "is 
usually done either by replying to inquiries with or without 
specifications, or by individual builders offering to prospective 
owners on their own initiative. In many cases the terms of pay- 
ment extend over a period of years, the effect being that in these 
cases shipbuilders virtually finance shipowners. Occasionally 
also shipbuilders put down vessels on their own account, so as 
to keep their yards going, in the hope of being able to dispose of 
the ships at a profit later. . . . Although there are exceptions, 
it appears, generally speaking, that while the majority of ship- 
building firms in this country have given long credits of from one 


to five years, or even more, to their English customers, they have 
usually insisted on being paid cash in their foreign business " »• 
(cf. pp. 116-7). 

In the Engineering trades the conditions of sale are very different. 
In that part of the industry which is concerned with the supply of 
machinery to meet special needs, " terms of payment " according 
to the Committee on the Engineering Trades ** are generally spread 
over the period of construction and erection, the manufacturers' 
terms involving no extended period of credit." ^' In the Yorkshire 
district inquiry shows it to be customary for Engineering firms 
to obtain one month's credit from iron and steel manufacturers 
and to grant credit for a similar period to the parties to whom they 
sell their products. Finally, throughout the motor-car industry, 
it seems to be customary for manufacturers to sell to retailers only 
for cash on delivery. 

These illustrations may easily be multiplied ; but they serve 
their purpose in bringing out the immense complexity of the facts 
with which we are dealing. That complexity is increased when we 
take account of the fact that the volume of trade credit is con- 
stantly changing under the influence of many conflicting causes, 
of whose relative importance little is known. The volume of goods 
has clearly been increasing. The numberPof owners through whose 
hands they pass grows with the increasing specialization of industry ; 
but this tendency to increase book debts is set off by the growth 
of co-operative stores and of large retailers who buy direct from the 
producers, and by direct marketing on the part of manufacturers 
of such commodities as boots, margarine, hats and so on. "... the 
tendency at present," says Mr. Abbott, " is in the direction of the 
gradual, the very gradual elimination of the wholesale dealer as 
such, and the assumption of his functions, wherever possible, by 
the selling departments of manufacturing businesses." There is a 
good deal of evidence showing that the period of trade credit was 
shortening prior to the war. Improved communications are no 
doubt largely responsible for this. " The old custom of buying 
heavily two or three times a year is now obsolete, and clever traders 
now buy from hand to mouth, weekly or even daily."*® Other 
influences have been the deliberate effort on the part of individual 
trades, the superior marketability of short trade bills and perhaps 
the growing wealth of the community. During the war the heavy 
pressure of demand, the influence of State control and the financial 
prosperity of many trades seem to have reinforced these tendencies 
to shorten trade credit, a strong instance being seen in the changed 
conditions in the Boot trade. But it is clearly too early yet to 
conclude that such changes are permanent. 

This great volume of book debts binding together the various 



parties to production has a twofold significance : in one aspect 
it is seen as an agency for the transport of capital ; in another as a 
supply of purchasing power, a means by which goods may be pur- 
chased without the immediate use of any form of currency. These 
two aspects must be examined separately. 

Mr. Weld, writing on mercantile organization in the United 
States, says : '* On the whole, the brunt of the financing burden is 
borne by the wholesale trades, or sometimes by commission mer- 
chants. Retailers and consumers are generally weak so far as the 
accumulation of capital is concerned, and on the other end of the 
marketing chain, manufacturers generally find it difficult to finance 
their own undertakings ; so that the financing function of the 
wholesale intermediaries commonly extends in both directions." ^ 
This statement can be applied only in a modified form to the United 
Kingdom, where the reserves of business firms are much larger in 
proportion to their activities ; but it would seem to be true that the 
function of supplying trade credit attaches essentially, though by 
no means solely, to the merchant ; it is a function which combines 
conveniently with that of holding large and varied stocks of 
materials required by manufacturers and retailers. 

Merchants and dealers are evidently in a very favourable 
position to make loans to manufacturers and retailers in the form 
of trade materials to be paid for at a later date. Their special 
knowledge of the character and means of their customers reduces the 
risks of extending credit without security of the kind required by 
a banker, and enables them to supply capital to many business 
men who would otherwise find it difficult, if not impossible, to 
obtain suppUes elsewhere. By their means many weak firms are 
enabled to survive temporary emergencies and many men are 
able to obtain the resources they require to begin business on their 
own account. In the Lancashire Cotton industry, for example, 
trade credit is important in enabling men to begin business in a 
small way. " In manufacturing in Lancashire," says Professor 
Chapman, " much industrial plant may be hired. Room may be 
rented and also power. Moreover, looms and other machinery can 
be obtained largely on credit. Payment by instalment is not un- 
common and the payment may extend over as lengthy a period as 
ten years. A manufacturer, too, may do his work on such terms, 
producing on commission ... or getting credit for yarn and 
accessories, and giving shorter credit for his deUveries of cloth, or 
even receiving cash, that the circulating capital which he has to 
find is relatively small." ^^ 

Similar facilities are found in the spinning branch of the 
industry. It would be a typical case, prior to the war, for a com- 
pany formed with a nominal capital of £100,000, to call up £10,000 


on its issued shares, and to get the remainder of its initial capital 
partly by the purchase of machinery on one or two years' credit 
and partly by arranging with a Liverpool broker either for further 
trade credit, or possibly for a loan on condition that he should be the 
sole broker through whom the company conducted its business.^^^ 

Again, the Board of Trade Committee on the Engineering trades 
cite an interesting case where a boot and shoe machinery company, 
by leasing machines to manufacturers, has " contributed in no small 
degree to the development of the boot trade in the Midlands." 
They make it clear, however, that they disapprove of the scheme, 
and point out that " the manufacturer, who most frequently 
starts as a very small man without capital, is all his business life 
tied hand and foot to the Machinery company." ^^^ Whether for 
good or evil, trade credit is not less important in maintaining the 
supply of small retailers. In a London suburb, prior to the war, 
a small grocery business could be established with a minimum 
capital of about £500. No less than one-half of this amount, it is 
stated, might be supplied by way of trade credit to a man with a 
good business record. Again, a capable man of good reputation, 
beginning business in the drapery trade, could, it is said, obtain an 
addition of one-third of his cash capital in the form of trade credit 
from a wholesale house. lo^ 

As the security against which trade credit is obtained consists 
mainly of the business reputation of the customer, it is only to be 
expected that the terms on which it is granted should be somewhat 
onerous. Prior to the war, the credit obtainable by the grocer was 
shorter than that granted to the draper, for he turned over his 
capital more rapidly. The recognized terms were : 3d. in the 
£1 discount for payment within fourteen days and net prices for 
payment at the end of two months. This corresponds to an interest 
charge of about 10 per cent per annum, for two months' credit, as 
compared with about 14 per cent per annum for three months' 
credit in the drapery trade and about 7 per cent per annum for 
credit up to six months granted by woollen and worsted manu- 
facturers in the sale of piece goods to merchants. 

These terms represent, however, only a portion of the burden 
falling on those who rely largely on trade credit ; they often carry 
with them a limitation of the freedom to buy and sell in the best 
market ; the debtor is tied, in a less degree, but in a similar way to 
retailers in such trades as brewing, tobacco and jewellery. Instances 
have already been quoted from the cotton and boot trades of the 
manner in which the debtor is required to buy exclusively from the 
party who has granted him trade credit ; they are plentiful in the 
retail trades and in agriculture. Mr. John Ross, who recently 
made an inquiry into the commercial relations prevailing in English 


agriculture, gives instances of the evils of long trade credit which 
are interesting, though there is no reason to suppose them to be at 
all typical. " The worst feature of this kind of credit, however," he 
says, " is where it is granted in consideration that the farmer shall 
sell his produce or crop to the tradesman, seedsman — or other . . . 
The price at which the produce, etc., is taken in exchange is 
often fixed entirely by the tradesman in his own interest . . . and 
the reduction of price is actually a second interest charge for the 
original advance." ^^ It is not to be supposed that the costs of 
trade credit are universally so onerous as these illustrations may 
suggest ; but the view that they are heavy is borne out by the 
general opinion that it is greatly to the advantage, at any rate of 
retailers, to be in a position to pay cash to the wholesalers and 
manufacturers with whom they deal.iw» 

In spite of the great complexity of the facts, the nature of 
trade credit, in its first aspect as a supply of capital, is found to be 
comparatively simple. It forms an agency supplementary to the 
banks by which business men supply trade materials for short 
periods to other business men of whose ability and integrity they 
are in a specially favourable position to form a sound opinion. 
In its second aspect as a supply of purchasing power, trade credit 
is less simple ; for not only are the essential facts more obscure, 
but the theoretical considerations by which those facts must be 
judged are themselves more difficult. 

Trade credit enables goods to be bought for payment at a later 
date ; it enables them to be bought without any immediate use of 
the existing stock of currency ; it forms, therefore, during the 
period it is outstanding, a net addition to the purchasing power 
exercised by the community. If its volume were constant, or 
changed only slowly, this effect would have little significance. The 
condition would be that there would be always outstanding in the 
hands of purchasers a certain quantity of goods for which no pay- 
ment had been made, and prices would consequently be a little 
higher than would have been the case had the existing stock of 
currency been drawn on to effect their purchase. 

In actual practice the matter is a little more complicated. In 
its simplest form, the purchasing power created by a trade credit 
is used only once ; it is employed to buy a quantity of goods ; and 
it enables the price of those goods to be driven upwards without 
drawing away currency from employment in the purchase of other 
things, and so without causing a fall in the prices of those other 
things. If, however, the credit is embodied in the form of a bill 
of exchange which is employed as a means of making further 
purchases, its effect on prices is multiplied by the number of times 
that bill is so used. Further, if the bill is discounted, or if in other 


ways the original credit operates as a means of drawing additional 
currency from the banks, its influence on price is likely to be still 
further increased. This, however, is only a complication ; so long 
as its volume and its methods of use remain constant, trade credit, 
from the present point of view, is of no great significance. 

It becomes significant when its volume, or method of use, changes 
considerably in shOrt periods ; when the volume of purchasing power 
to which it gives rise expands or contracts on a scale which causes 
appreciable fluctuations in prices. The question, therefore, with 
which we have to deal is this : What is the importance of trade 
credit in initiating changes in the purchasing power of the sovereign 
and the disturbances which these changes introduce into the 
adjustment of social resources to social needs ? 

That trade credit has been an important disturbing influence 
in the past is shown by J. S. Mill. " Of the extraordinary height," 
he writes, " to which speculative transactions can be carried upon 
mere book credits, without the smallest addition to what is commonly 
called the currency, very few persons are at all aware. ' The power 
of purchase,' says Mr. Tooke, * by persons having capital and credit 
is much beyond anjrthing that those who are unacquainted practi- 
cally with speculative markets have any idea of ... a person having 
the reputation of capital enough for his regular business, and 
enjoying good credit in his trade, if he takes a sanguine view of 
the prospect of a rise of price of the article in which he deals, and 
is favoured by circumstances in the outset and progress of his 
speculation, may effect purchases to an extent perfectly enormous, 
compared with his capital.' Mr. Tooke confirms this statement 
by some remarkable instances, exemplifying the immense purchasing 
power which may be exercised, and rise of price which may be 
produced, by credit not represented by either bank notes or bills 
of exchange." ^^ 

The potentialities of trade credit as a means of causing wide 
fluctuations in the volume of purchasing power are clear enough ; 
the difficulty is to know how far they are actually operative in 
modern business conditions. 

Local changes in the volume of trade credit are certainly a 
cause of fluctuations of price in particular markets. The pre-war 
practice of buying leather by means of three months' bills was 
responsible, according to the Boot and Shoe Trade Journal, for 
considerable speculative price Again, " Some of 
the chief products of ore and coal," says Dr. Marshall, " can be 
graded fairly well ; the demand for them is liable to extreme 
fluctuations under the influence of commercial credit generally, 
and especially in the credit which the public accords to new joint- 
stock companies and extensions of old companies." ^^^ In the 


most highly organized markets, dealings in " futures " enable 
people of all kinds to buy produce freely without the use of any 
money beyond that required to cover adverse price differences 
occurring during the course of their contracts. Such public 
facilities for buying without money almost inevitably tend to dis- 
tort prices ; for it seems tolerably certain that any beneficial 
influence which dealings in futures may have in smoothing out 
the larger price fluctuations is due less to these special facilities 
for purchase than to the scope which the system affords for bear 
operations by skilled speculators. In the analogous case of the 
Stock Exchange in pre-war days, the period for which securities 
could be bought on credit was curtailed by the practice of a 
fortnightly settlement ; but the existence of this period and the 
great ease with which money could then be temporarily borrowed 
from a broker in order to " carry over," and so extend a credit 
purchase, greatly promoted price fluctuations in many speculative 

Trade credit, by promoting local price fluctuations of this kind, 
necessarily adds to the uncertainty of business and diverts energies 
to the acquisition of profits which add nothing to social wealth ; 
its chief interest, however, lies in its more general changes, and in 
the effects of these changes on the course of business cycles. What 
changes occur in the volume of trade credits during periods of rising 
confidence and growing business activity, and what influence do they 
exert on the upward movement of prices by which the intensity of 
the cycle is reinforced ? 

General reasoning does little more than add to the difiiculties 
of finding an answer to this question. It shows that at such times 
there are influences working both for and against an expansion of 
trade credits. In so far as shipbuilding is in this respect typical 
of industry generally, the example quoted on page 117 shows that in 
times of active business, producers " stiffen their backs " and grant 
shorter terms to the parties to whom they sell. At such times, too, 
the greater profitableness of business must enable merchants and 
retailers to buy more largely for cash ; though this tendency is likely 
to be neutralized by the larger volume of their current purchases. 
These considerations carry with them the disconcerting suggestion 
that trade credits, so far from expanding, may even contract during 
periods of growing business activity. There is, however, a strong 
influence working in the opposite direction. Periods of rising con- 
fidence are periods of anticipation of profitable future sales ; they 
are, therefore, periods of keen demand for the materials by means 
of which these profitable future sales may be realized. At such times 
producers, needing all their resources to expand their output, may 
well shorten the period during which they are prepared to wait for 


the payment of goods which they actually deliver ; but such action 
will not curtail the use of that more tenuous form of trade credit which 
is exercised in speculative purchases on the organized markets and 
in orders given by merchants and other parties for goods to he 
delivered at a future date. A growing expansion in the volume of 
contracts for future delivery, involving a continuous creation 
of purchasing power and a continuous rise of prices, may clearly 
go to great lengths ; its only limits will lie in the credit of the 
purchasers, the cash deposits they may be required to make on 
their contracts and their confidence in being able ultimately to sell 
their purchases at a profit. 

Evidence of what actually occurs at such times is scanty. One 
clear fact is the increase in both France and Germany in the number 
of bills created during periods of growing business activity. M. 
Roulleau points out that in France the larger bills — those of about 
£200 — show a marked increase at such times and reach their maxima 
in the years of crisis ; he adds that business men in commerce and in- 
dustry in general draw their bills only when they want to discount. 1*** 
These facts suggest that trade credit in its full sense — the actual 
delivery of goods for payment at a later date — does expand during 
such periods, but does so by means of resources obtained from the 
banks. Whether or no this is true of England, post-war experi- 
ence shows clearly how business activity increases the volume of 
trade credit in its more limited form — that of contracts for future 
delivery in the speculative markets and throughout industry 
generally. The heavy pressure of demand which followed the close 
of the war led, as is well known, to merchants and other parties 
placing orders for iron and steel products, motor cars, pottery, 
textiles and other goods for delivery many months, even years ahead. 
In exceptional cases these orders were accompanied by the payment 
of a cash deposit ; but broadly speaking they were purchases which 
involved the use of no money until the contract was completed by 
actual delivery. If it is denied that the pressure of these orders 
raised prices, reference may be made to many specific statements 
by producers that in order to avoid further commitments they have 
quoted prices which they intended to be prohibitive but which were 
in fact immediately accepted by their customer. 

It seems reasonable therefore to conclude that periods of rising 
confidence, based on the anticipation of profitable future sales, lead 
to an expansion of contracts for future delivery both in the specu- 
lative produce markets and throughout industry in general ; that 
this expansion involves the creation of additional purchasing 
power ; and that this additional purchasing power exerts a powerful 
upward influence on prices, which reinforces confidence and em- 
phasizes the intensity of the business cycle. The influence of trade 


credit in this way in increasing the volume of purchasing power is 
no doubt partly dependent on the anticipation of a subsequent 
expansion of bank loans, and its effects are bound up with those of 
other changes, such as more rapid investment on the part of the 
public. But it seems impossible to doubt that the large variations 
which occur in the volume of contracts for future delivery are an 
important cause of the wide and frequent fluctuations in the prices 
of goods in the hands of merchants and manufacturers. 



THROUGHOUT this book the work done by the various 
market agencies has been considered with a view to 
bringing out the nature and importance of the economies 
they effect in faciUating the movement of capital in the 
direction required by the social interest. This method of treatment 
has made it impracticable to separate that part of this work which 
deals with the supply of capital to parties who employ it to increase 
their current consumption from that part which is concerned with 
the supply of capital to those who employ it to maintain and increase 
the accumulated stock. By so doing, it has tended rather to obscure 
the position occupied by the market in the social machinery for 
production. If the market agencies are considered in that aspect 
of their work in which they are engaged in supplying capital for 
business purposes they are seen to form an organic part in the 
organization of society as producer. 

Society has, on the one side, resources and, on the other side, 
wants ; its object as producer is to adjust the one to the other in a 
manner which yields the maximum return. The parties to pro- 
duction may be separated into groups in accordance with the 
function they perform — the nature of the services they supply : 
first, the Landowners who let on hire the free gifts of nature ; second, 
the Capitalists who supply the products of past labour ; third, 
Labour, which supplies subordinate manual and mental services. 
Each of these three groups is linked by its appropriate 
marketing organization to a fourth group of Entrepreneurs, or 
business men, whose function it is to assume the responsibility and 
control of production. They combine the services of land, capital 
and labour with their own, and apply them to their productive 
uses in satisfaction of social wants. 

Regarded realistically, a single person may be found to belong 
to several of these classes : a railwayman may belong to the group 
of labour inasmuch as he works for a wage ; he may have savings 
which constitute him a Capitalist ; and he may be an Entrepreneur 
in so far as he participates in railway management. But, although 

confused in the concrete, these classes are distinct in function and 



may quite properly be grouped in accordance with the nature of the 
service which each contributes to production. 

In this way we may speak of a distinct class of business men who 
have at their disposal all the productive resources of the community. 
The services of the hundreds of grades of labour are made over to 
them with the assistance of Employment Exchanges, Trade Unions, 
newspapers and the more indefinite machinery of the labour market ; 
the available capital of the community passes under their control 
with the aid of the Money Market, Business men, having made 
their forecasts of social needs, and having organized the resources at 
their disposal, turn their multitude of products into the markets. 
This continuous flow into the markets is followed by a continuous 
process of exchange, by means of which the products forming the 
output of society as producer are redistributed and reappear as the 
real income of society as consumer. 

The agencies forming the Money Market, in that aspect in 
which we are now regarding them, lie then between the group 
of capitalists and the group of business men ; they facilitate the 
movement from one to the other of the control over that part 
of the resources of society which is annually devoted to the 
maintenance and extension of the accumulated stock of capital. 
They correspond to what Dr. Marshall describes as the " Organiza- 
tion by which the appropriate business ability and the requisite 
capital are brought together " and made effective for production.^^** 
In so far as business ability and capital are not already in 
the same hands, or joined together by private negotiation, these 
agencies take over from the capitalist, in some cases wholly, in 
others partly, the work of management associated with the supply 
of capital. Their organization is placed at the disposal of the 
capitalist only, of course, at a price. The payment which they 
receive consequently enters into the expenses of production of those 
firms who obtain their capital by means of the market. So, too, 
the equivalent of this payment forms an addition to the profits 
of those firms whose capital and business ability is associated 
without the assistance of the market. It is those additional 
profits (in so far as they are rightly interpreted here) which form 
the difference between " net " and " gross earnings of manage- 
ment " as conceived by Dr. Marshall. 

At this point there arises the question : What is the scope 
of the work done by these agencies ; what proportion of the annual 
flow of capital passes through the market ? If the question 
referred to our foreign investments, a fairly definite answer could 
be found by a reference to the table and the accompanying text 
on page 186. The answer would be that much the greater part of 
these investments were made tlirough the market and that the 


agencies by which they were effected were principally the securities 
market and the Trust, Financial, Land and Investment com- 
panies. It is much less easy to find any definite answer to the 
question : What proportion of the annual flow of capital applied 
to business uses in this country is transferred to business men 
with the assistance of the market ? 

Much the larger part of this annual flow (cf. p. 69) consists 
of resources devoted to the renewal of stocks of materials and 
the upkeep of plant. The bulk of these replacements presumably 
takes place by way of allocations from gross profits applied directly 
by the owners in whose hands those profits arise. But a sub- 
stantial part is effected by means of the banks and the organization 
of trade credit ; for a typical operation of the English banks is 
one by which they finance the heavy autumnal purchases of raw 
materials made by the cotton industry, gradually recovering their 
loans during the following summer as these materials pass through 
the industry into the hands of consumers. The resources con- 
trolled by the banks and those devoted by business men, from 
their own means, to supplying goods against deferred payment are 
perhaps most conveniently regarded as a stock : a stock employed 
partly in initiating new investment ; but employed mainly in the 
continuous replacement of materials at each stage of production 
and recovered as they move towards succeeding stages. 

It is of more interest, however, to inquire what work is done 
by the market on the latter part of this annual flow : the stream 
of resources applied to increase the stock of materials, plant, 
buildings and so on in this country. Of the average volume of 
new home investment, or of its annual fluctuations, little is known 
statistically. As an indication of our total annual investments, 
there is Mr. Flux's estimate that in 1907 about one-sixth of the 
total national output, say £330 m., was available to add to our 
accumulated stock of capital. ^^^ As an indication of our annual 
foreign investment there is Mr. C. K. Hobson's estimate that 
the average volume of our capital exports for the three years 
1908-10 was £130 m. ; ^^^ an estimate in rough agreement with 
Sir George Paish's statement that " the actual amount of new 
capital supplied by Great Britain to other lands was : in 1908, 
£130 m. ; in 1909, £160 m., and in 1910, £165 m. . . ." ^^^ 
The difference between these two sets of figures agrees fairly well 
with the estimate of £200 m. devoted to home investment in 
1907.^^* A little reduced by an allowance for investments in 
furniture, public parks, and similar non-business uses, it gives 
an idea of the order of magnitude of the annual stream of resources 
devoted to capital uses at home. The figures are, of course, highly 
conjectural ; but not more so than the argument which follows. 


Sir Robert Giffen, writing in 1889 on The Growth of Capital, 
said, "... the regular annual investment by individuals in their 
own businesses or properties . . . must always be the most 
important form of saving — far more important than the visible 
public investments." 

If the term " investment " is taken to exclude the export of 
capital and subscriptions to war loans and similar issues, and is 
taken to include only the additions to the home stock of accumu- 
lated capital, this statement seems still to be true, in spite of the 
development of the market during the last twenty-five years. 

At first sight it appears to be contradicted by the work of 
the securities market : by the fact that substantially the whole 
of the immense amounts of capital controlled by such undertak- 
takings as railway, telegraph, tramway, electricity, gas and water 
companies, have been supplied through this agency. But the 
construction of these means of communication has been spread 
over a long period of time, and the annual additions are now not 
large. Prior to the war, for example, British railways were raising 
new capital on the London market to the extent of no more than 
£2 m. per annum ; while the total annual addition to the capital 
of gas and tramway undertakings was under £5 m. ; moreover, 
in municipal concerns of this kind, there is at least a legal pro- 
vision for the repayment out of profits of the capital embarked 
in the undertaking. 

Every year a considerable stream of resources is supplied by 
the securities markets for such purposes as the development of 
new coal areas, the formation of insurance companies, the con- 
struction of ships for small shipping companies, of cotton spinning 
factories and picture palaces ; and for the extension of docks and 
harbours, iron and steel works and a multitude of other under- 
takings. This stream is conspicuous and its volume considerable : 
but it seems to be of quite secondary importance in relation to 
the flow of resources by way of private contract and the reinvest- 
ment of profits. This opinion may seem more reasonable if a 
few illustrations are taken from particular industries in order to 
suggest the manner in which businesses obtain the resources 
required for their formation and extension. 

The most conspicuous instances of joint-stock organization 
are the banks and the insurance companies ; they obtain practi- 
cally the whole of their paid-up capital through the securities 
market. But even here the work done by the market is easily 
overestimated ; for to find the total capital controlled by those 
organizations we must add in their reserve funds and immaterial 
business organization, both of which are created by the direct 
investment of undistributed profits. How substantial this 


addition may be is shown by the fact that the reserve funds of 
the EngHsh joint -stock banks are nearly equal in amount to their 
aggregate paid-up capital. The use of the public joint-stock 
company as a means of obtaining capital for the creation of new 
undertakings is again especially marked in cotton spinning. But 
the initial capital which a new undertaking obtained in this way, 
in pre-war days, was comparatively small, perhaps £10,000 on 
the average. Much was obtained by way of trade credit and bank 
loans, and was repaid out of profits as the company gradually 
grew to its full strength. 

In the weaving of cotton, where less initial capital is required, 
the work done by the securities market is still less. This would 
be a typical method in which the industry has grown in north- 
east Lancashire. Initially, a Room and Power company buys 
an existing mill, or builds a new one, and offers it, in floors, to 
tenants ; while a speculative builder, anticipating demand, runs 
up cottages for later sale. A small weaver, aided by trade credit 
from the machinery makers and possibly by a loan from a bank, 
hires power and a floor in the mill and begins work with perhaps 
a hundred looms. As accumulating profits increase his resources, 
he multipHes the number of his looms. The same process con- 
tinued in his own or a second generation enables him to build a 
new mill, to repay the mortgage with which it is charged and to 
build another. At least one large centre in Lancashire has developed 
in this way, expanding and subdividing like an organic thing.^^^ 
Trade credit and the banks have been important in early growth, 
but the body of the industry has been formed by the reinvestment 
of accumulated profits. 

Again, the Belfast linen industry seems to have obtained little 
of its capital from the public sale of stocks and shares ; the great 
bulk of it has apparently been drawn from profits and by the placing 
of the securities of private joint -stock companies among parties 
associated by personal or business interests. 

In the building trades and in agriculture, joint -stock companies 
are rare. According to business men in the Rushden (Northants) 
district, capital in the boot trade is derived mainly from savings. 
" Most of the large businesses have started in a very small way 
and gradually have been extended as the owners' means have 
increased. Most of the capital in the trade has been made in it 
and capital provided by friends and relatives owes its origin to the 
same spring.*' 

In the woollen and worsted industries the practice of ob- 
taining capital by the public sale of securities has made no 
great progress ; "... the family business," says Dr. Clapham 
" though it may have assumed the company form, is still the 


prevalent type." "... mills that accommodate more than one 
manufacturer, and firms that start in a humble way by working on 
commission for their neighbours, are still common enough. . . . 
There is still room for the small employer, although his sphere 
of action tends to get narrowed year by year." ^^^ The Wool Y ear- 
Book gives an impressive list of the private fortunes made in the 

According to good authorities, the heavy iron and steel trades 
in the north of England originated as private undertakings and 
grew mainly by the reinvestment of profits. They were later 
converted into private, and to a less extent public, joint -stock 
companies, largely because of the heavy risks to which the in- 
dustry is exposed. The securities market has aided little, if at all, 
in their formation ; but in the past the sale of securities in local 
markets, and, during the last ten years, the public sale of securities 
on the London market, has provided the resources necessary for 
their extension. 

So, too, with the shipbuilding and ship-repairing firms on 
Tyneside. Originating almost without exception as private under- 
takings, they have grown by means of resources supplied by profits, 
partnership and private contract. Some have passed into joint- 
stock form and obtained a good deal of their capital from pubUc 
subscription, but only a relatively small part of the total capital 
of the industry seems to have been obtained in this way. 

In the Yorkshire district it appears : " The Engineering trade 
gets its capital mostly from inheritance and savings. A great 
majority of the firms have begun in quite a small way ; a single, 
capable and thrifty workman, or two or three such men, have started 
in a very small way ; one could give scores of such cases . . . 
partnership certainly provides some of the permanent capital. It 
is no uncommon thing for a small engineer to secure as a partner a 
man with capital which can be used to develop the business. . . . 
Capital is not, as a rule, obtained from the public by floating joint- 
stock companies. Cases of this kind are very rare. ... It has 
happened in the case of one or two companies making electrical 
appliances. I have not been able to find examples of joint -stock 
companies issued to the pubUc locally. Most of the joint -stock 
companies in the trade are simply conversions. . . . My in- 
quiries lead me to believe that trade bills do not to any great 
extent help engineering firms to obtain money from banks. Over- 
drafts are not uncommon, and some of the old small banks have 
done exceedingly well for themselves and have helped to build 
up very successful engineering businesses by the way in which 
they granted overdrafts to men and firms with good business 
reputations." ^^^ 


These illustrations may be supplemented by considering a 
sample of ninety-one of the leading firms of Gloucestershire (ex- 
cluding Bristol) in 1904. Of these, 54 were private firms, 37 were 
limited liability companies ; and of these 37, only four or at most 
seven originated as joint-stock concerns ; the remainder were con- 

These data are fragmentary ; but taken in conjunction with 
the considerations of Chapter XXXI they convey a fairly clear 
impression that the amount of capital annually passing through 
the securities market and applied to the extension of the business 
equipment of the country is comparatively small, and is probably 
in the neighbourhood of one-quarter of the whole. 

A substantial part of the total free resources of the country 
is placed under the control of the banks in the form of lodgments 
on current and deposit accounts. The greater part of this, it 
would seem, is employed in financing commercial processes origin- 
ating in the continuous replacement of the streams of materials 
passing through the successive stages of production. Some part 
of the remainder, some unknown fraction of the total volume of 
outstanding loans and advances, is applied each year to the ex- 
tension of stocks, machinery, plant and buildings. This fraction 
forms a part of the annual flow of resources into new home invest- 
ment. Supplied generally for comparatively short periods, it 
serves to initiate the profit -making process and is normally repaid 
from profits as they accrue. 

Pass now to the outer market. Little or nothing need be 
added for the work done by the organization of trade credit. The 
resources supplied in this way are drawn from the banks and 
business houses generally and are applied mainly to the mainten- 
ance of existing stocks. Some of these resources, no doubt, are 
applied to the extension of business. But in so far as they are 
drawn from the banks, they have already been reckoned ; and 
in so far as they are drawn from other business houses, they 
consist of resources which presumably would otherwise have been 
invested directly by the business house in the extension of its own 

A final addition must be made for the work done by Building 
Societies, which in 1913 advanced some £9 m., and for that of 
solicitors who facilitate the movement of capital against mortgage 
and similar security into such uses as the development of agricul- 
ture and the construction of buildings. This work no doubt is 
substantial in volume, but its amount cannot be estimated. More- 
over, it has no natural boundaries and shades off imperceptibly 
into the common business practice of obtaining capital by way of 
private contract. 


Since the boundaries of the Money Market in its widest sense 
are themselves indefinite, the scope of its work cannot be defined 
in figures. But if account is taken only of the specialized organiza- 
tions forming the Money Market proper, it seems reasonable to 
conclude that the resources which are annually applied, through 
their agency, for the expansion of the business capital of the 
country probably do not amount to one-half of the total annual 
stream of new home investment. It seems still to be true that 
the predominant methods by which business men in this country 
are supplied with the resources they require to extend their opera- 
tions are those where the economic distance to be bridged is small, 
where capital has not " far to go," where the sources of demand 
and supply are connected by personal or business ties, or in the 
limit are identical. It is supplied mainly, it may be presumed, by 
way of partnership, in that broad sense of the term in which it 
includes private joint -stock companies ; by way of borrowing 
from personal and business friends ; and above all in the form of 
the persistent reinvestment of profits by which small businesses 
are continually growing into large undertakings in almost all 
branches of industry and trade. 

The proportion between the work done by the market in supply- 
ing capital for business uses and that done by business men on their 
own account has in itself no great significance. The important 
consideration is that the services of the market should be adequate, 
on the one hand, to draw forth savings which in the absence of 
facilities for investment would not be forthcoming ; and, on the 
other, to ensure that capital is evenly distributed throughout its 
field of employment. The English market has clearly a powerful 
influence on supply ; for, by taking over from the investor many 
of the risks and much of the trouble involved in home and foreign 
investment, it greatly increases the annual volume of saving. Its 
work is not less important in facilitating the movement of capital 
into its most profitable uses. By the ease with which it transfers 
capital rapidly from one point to another, it enables business men 
to meet temporary emergencies and to exploit opportunities for 
which their own means are inadequate. By supplying business 
ability, as it emerges, with the resources which make it effective, 
it helps to maintain the vitality of industry. By promoting the 
ready flow of capital abroad it enables us to establish claims on the 
produce of those countries on which we are dependent for our 
supplies of food and raw material. In one part of its work it 
increases that portion of the productive energies of the country 
which may be employed in making provision for the future ; in the 
other it enables those energies to be applied in their more profitable 
uses ; in both, it increases the National Dividend. 


THE occasional acknowledgments made in these notes to 
Dr. Marshall and Professor Pigou are a very imperfect 
recognition of the extent to which I am in their debt. 
From their writings and teaching are derived most of 
the general conceptions in the book which are tolerably certain 
of acceptance. The treatment of the subject is indeed little more 
than a development, right or wrong, of leading ideas which they 
have laid down. I have also to thank Professor Foxwell for several 
valuable suggestions ; Mr. Henderson of Clare College and Mr. Pott 
of the London Stock Exchange for reading over parts of the manu- 
script ; Mr. K. Broadley and other gentlemen for inquiries made on 
my behalf ; and Mr. Richardson of Emmanuel College for his assist- 
ance in the correction of proofs. 

1 The phrase " power to borrow " is not quite wide enough ; for the ability 
of a joint-stock company to obtain additional supplies of capital by the sale 
of its shares involves the use of its credit, but is not strictly an act of borrowing. 
There is much to be said in favour of regarding a credit and a debt as two 
aspects of the same thing ; but this use of the term would require us to mean 
by a man's " credit " the volume of debts owing to him, i.e. the actual and 
not the potential volume of his debts. On the whole, it seems slightly more 
convenient to follow Mill, and use the term as broadly equivalent to the 
" power to borrow " rather than to actual borrowings. This is the sense in 
which it is used in this book, except when dealing with trade credit, where 
the context makes the meaning tolerably clear. 

2 History of British Commerce, 2nd edition. 

* Prof. Lehfeldt, in his Gold, Prices and the Wiiwatersrand, 1919, endeavours 
to find how far the various currency devices, such as cheques and notes, 
have been successful in economising gold. He gives estimates of the pro- 
portions, in various countries, between the total amount of currency held 
by the public and the total amount of gold held by the public and the banks 
together. This " currency factor " is estimated to have been in pre-war 
days : — For the United Kingdom perhaps 5-6 ; for the U.S.A. about 5-5 ; 
for France perhaps 2-3 ; for the world (excluding India and China) probably 
between 2-5 and 3-0. 

* Report of the Indian Industrial Commission, 1916-18 (Cmd. 51), p. 

» Ency. Brit., art. " Stock Exchanges." 

The character of French investment differs sharply from that of invest- 
ments by other countries. In Great Britain, Germany and the United 
States, according to M. A. Neymarck, the greater part of the securities held a 
few years prior tP the war were of the kind yielding a variable return ; while 



in France no less than three-quarters of the securities held were in the form 
of state and municipal loans and bonds yielding a fixed rate of interest. No- 
where else but in France, he says, is there found so great an accumulation of 
capital belonging in great part to the small capitalist. Of the disposable 
French savings, he estimates that an average amount of £60 m. annually 
passes into valeurs mohilUres. (A. Neymarck, Finances Contemporaines, vii.) 
According to Prof. B. M. Anderson {Effects of the War on Money, Credit and 
Banking, 1920, p. 38), " The direction of French investment . . . has been 
subject, not to the free movement of capital, sent piecemeal under competitive 
conditions, by alert investors, to those lines of investment which promised 
the best yield for a given degree of safety, but has been controlled by a few 
great banks, working to a large degree in harmony, acting for a passive body 
of depositors, and controlling public opinion through the press. In choosing 
the investments, these bankers have in no small degree been moved by the 
fact that certain lines of investment gave them higher commissions than 
others." " There can be little doubt that in many of these operations French 
bankers have shown themselves greedy in a marked degree, and that the 
greed has been largely at the expense of their confiding clients." He points 
out that selling costs have been high, and quotes an opinion that " The profit 
is rarely less than 5 per cent of the selling price of the issues." 

• Lehfeldt, Gold, Prices and the Witwatersrand, App. A. Estimate of 
gold in circulation in the U.K., outside the banks, 1910, ^^84 m. 

' Ibid., App. A. 

^ " It would seem that the number of cheques stamped in 1919-20 was 
approximately 360,000,000, as compared with 312,000,000 in 1913-14 and 
324,000,000 in 191 7-18." — Reply to Parliamentary Question by the Chan- 
cellor of the Exchequer. See Times, 20 May 1920. 

"It is stated by bankers who are likely to be well informed that the 
cheques which do not pass through the Clearing House in this country are 
probably as great in amount as the cheques which do pass through the 
Clearing House, so that the daily circulation in this way, reckoning by the 
amount of cheques actually paid in any one day, must exceed or be about 
£50 m." — Giffen's Statistics, p. 315. 

The value of cheques, etc., passing through the Bankers' Clearing House 
in 1920, was ;£39,ooo m. 

• Lehfeldt, op. cit., p. 41. 

1" The following estimates of the money of Germany are given in Currencies 
after the War, 1920 (League of Nations publication) : — 

June 1914. June 1919. 

Gold at Spandau .. .. .. .. 15 — 

Gold in Reichsbank . . . . . . . . 64 56 

Silver in Reichsbank . . . . . . . . 17 9 

Gold in hands of public . . . . . . 100 -^ 

Silver in hands of public . . . . . . 50 j^^ 

Reichsbank notes . . . . . . . . 120 — 

Darlehnskassenscheine . . . . . . — 40,000 m. marks. 

1* " A German merchant may have ;^5ooo to ;^io,ooo in notes in his safe 
and not think it unusual." — General Manager of a large English bank, 1916. 

" In Germany the cheque appears to be used mainly for local and foreign 
transactions. Its development has been hindered by the existence of the 
Giro system of the Reichsbank, the Great Banks and the Post Office, by 
means of which the great mass of distant payments within the country is 

NOTES 285 

carried through. Anyone who wishes to make a payment elsewhere usually 
hands to a bank, or a post ofi&ce, cash or an order on his account, together 
with a statement of the party or parties to whom this amount is to be trans- 
ferred. The bank or post office then undertakes the payment of these 
amounts either directly, or to the account of, the distant parties. The cheque 
law of 1908 has removed many of the obstacles to the growth of the cheque 
system. It is stated that in 1907 the number of cheques paid by the Deutsche 
Bank exceeded 10,000 daily, the total amount paid during the year being 
about ;^25o m. 

Miscellaneous Articles on German Banking : " The Giro System " ; " The 
Use of Cheques in Germany." Also, Riesser, The German Great Banks, pp. 
149 and 217. 

^* The following estimates of the money of France are given in Currencies 
after the War, 1920 : — 

June 1914. Jan. 1920. 

Gold in Bank of France . . 162 223 (;^79 m. held abroad) 

Silver in Bank of France . . . . 26 10 

Gold in hands of public . . . . 200 100 

Silver in hands of public . . . . 60 80 

Notes in circulation . . . . 242 38,000 m. francs 

It may be noticed that Th6ry's estimates of the amount of gold and silver 
money in public circulation in 1908 were substantially lower than these : 
i.e.. Gold, ;^I24 m. ; Silver, ;^47 m. — La Fortune publique de la France, 

" The number of cheques issued in France doubled during the fourteen 
years previous to 1912. In that year the number of cheques issued was 
fifteen millions, the average value being ;^230, and the aggregate value 
;^340o m. 

M. Roulleau gives the following estimates : — 

Bank-notes daily passing from hand to hand . . . . ^^220 m. 

Gold daily passing from hand to hand . . . . . . ^230 m. 

Cheques in circulation on any one day . . , . . . ;^i3 m. 

Cheques in circulation on any one day, U.K. . . £60 m. to ;^8o m. 

He points out that the French practice of accepting bills at the house of 
the drawee, instead of at a bank, leads to an extravagant use of currency. 
The private banker presents his bills just before maturity to the Bank of 
France and receives cash for them. This cash is paid out to his customers, 
who employ it to pay the bills presented at their houses. The bills so pre- 
sented by the Bank of France number hundreds of thousands. — G. Roulleau, 
Les Riglements par effets de commerce, 191 4. 

15 Report of Gold Production Committee, 1918, App. A. The decline 
has continued. In 1920 the total output was ;^7o m. 

" U.S. Mint Report, 191 5, p. 63. Quoted in Lehfeldt, Gold, Prices and 
Witwatersrand, p. 8. 

1' Quoted by Riesser, The German Great Banks, p. 238. 

" " The fluctuations in the value of what we use as our standard are ever 
either flurrying up business activity' into unwholesome fever, or else closing 
factories and workshops by the thousands. ... I shall argue that . . . the 
only effective remedy for . . . [the greater part of the fluctuations in general 
prices] is to be sought in relieving the currency of the duty, which it is not 
fitted to perform, of acting as a standard of value ; and, by establishing in 


accordance with a plan which has long been familiar to economists, an autho- 
ritative standard of purchasing power independent of the currency." — Dr. 
Marshall, art, in Contemporary Review, March 1887. 

!• " But after all, the fluctuations in prices from decade to decade are 
small in the aggregate as compared with those from year to year, and contri- 
bute but a very small share to those uncertainties of business which are the 
cause of so large a share of human sufiEering and degradation." — Dr. Marshall, 
art. in Contemporary Review, March 1887. 

20 Cd. 9182. 

21 Principles of Economics, 5th ed., VI. vi. § 6. 

22 The Export of Capital, p. 204. 
2* Goschen's Essays. 

24 Estimate by the New York Times, quoted by S. S. Pratt in The Work of 
Wall Street, p. 143. 

2« The Wealth of Nations, Book I., ch. 10. 

2« Riesser, The German Great Banks, p. 95. Prof. Pigou, writing in June 
1918 {Economic Journal), estimated that at the end", of the war our 
holdings of securities might amount to 60 per cent of the national 

2' The Credit Foncier, a state-aided and privileged institution, is the only 
important mortgage-bond company lending on land situated in France, Its 
principal business consists, on the one side, in borrowing from the public at 
about 3 per cent against the issue of debentures ; and on the other, in lending 
at about 4 per cent, for periods up to 75 years, to landowners, municipalities, 
etc. In 191 1 it had outstanding : — Debentures, £1$^ m. ; loans against 
mortgages, ;^92 m. ; communal loans, f%2. m. The average cost, borne by the 
applicant, was about 3^ per cent of the loan. The main purpose of the 
institution was to aid agriculture ; but for one loan made in the country it 
makes twenty-two in a city, where the trouble and expense of the operation 
are lower. — M. T. Herrick, Rural Credits, 1914. 

28 " Much of the present-day underwriting is done on the Stock Exchange, 
and a member will approach another with sometimes little more than a slip 
of paper, upon which are jotted brief particulars of the people connected with 
the matter, the proposed capital, profit estimates, etc. The names on the 
paper are what really count, and if first-class people are connected with any 
concern, underwriting will present no difftculties." — Investors' Monthly 
Manual, 1910, p. i. Lecky's view of credit is interesting in this connexion. 
In his Rationalism, p. 348, he maintains that it " has long proved one of the 
great moralizing influences of society, by the immense importance it has 
bestowed on character. ..." 

29 " By their system of granting cash credit to any individual able to ofifer 
a satisfactory security, even if it be no more than the guarantee of two 
respectable householders, the Scotch banks have raised many a penniless 
struggler to a position of competence, ay, of absolute eminence." — L. Levi, 
History of British Commerce, 1880, p. 287. 

80 Herrick, Rural Credits. 

31 Th6ry, La Fortune publique de la France, 191 1. Riesser, The German 
Great Banks, p. 224. 

32 " Notes on Mortgage Law and Valuations," A. L. Cox, Transactions 
of Surveyors' Institution, 1912-13. "The Development of Building Land," 
J. J. Done, Transactions, 191 1. 

'3 G. Biddell, Loans of Local AtUhorities, pp. 10 and 11. See note 69. 
»* Information collected by Mr. T. Liddle in Sunderland, and Mr. A. L. 
Ayre, of Newcastle. 

NOTES 287 

»' Various documents relating to Germany, published by the U.S.A. Nat. 
Mon. Commission. 

*' Fourth report by A. Neymarck to La Statistique Internationale des 
Vahurs MobilUres. 

" In 1845 the amount of capital in Prussia is estimated to have been £36 
per head, in England ^^143 per head. — Schmoller, quoted by Dr. Riesser in 
The German Great Banks, p. 28. 

" The establishment in Germany of special banks of deposit was out of 
the question, mainly because, in view of the low level of prosperity of the 
population, such banks would not have yielded sufficient profit." — Ibid., 

pp. 336-7- 

*» " Even in 1848 John Stuart Mill observed that ' the control of the opera- 
tions of industry usually belongs to the person who supplies the whole or the 
greatest part of the funds by which they are carried on. . . . It is not un- 
charitable, however, to conjecture that, with ordinary humanity, the natural 
way to dispose of savings, which could not be used for display or self-indulgence, 
was in business investment. And here we have doubtless the explanation to 
a large extent of the way in which capital was found in middle- class business 
circles to finance the new inventions." — W. J. Ashley, The Economic Organiza- 
tion of England, pp. 156-9. 

In the woollen and worsted trades. Dr. Clapham points out, the growth 
of the factory system in the North was accompanied, throughout the nine- 
teenth century, by a transfer of capital from commerce to industry, mercantile 
firms buying and building mills. In the cotton trade "... the men who 
prospered were raised by their own efforts — commencing in a very humble 
way — and pushing their advance by a series of increasing exertions, having 
a limited capital to begin with, or even none at all. . . ." — P. Gaskell, Artizans 
and Machinery, p. 618, quoted by Cunningham in his Growth of English 
Industry and Commerce. 

" Mr. Wilson, in his work on Capital, Currency and Banking, estimated 
that the annual accumulation of property in the United Kingdom, between 
1840-45, could not be less than sixty millions sterling. And though a 
large portion of such saving was required in the numerous branches of in- 
dustry for their own improvement and extension, there was at that time a 
large surplus of capital in quest of promising employment." — L. Levi, History 
of British Commerce, p. 302. 

^^ This process of amalgamation is by no means a recent development. 
During the three decades following 1877, 1887 and 1897, the average numbers 
of banks disappearing annually as a result of amalgamation were : — 4*2, 11*7, 
and 85 respectively. See art. by D. Eraser, Journal of Institute of Bankers^ 
1908, Early in 1920 there were in England and Wales twenty-one joint-stock 
and six private banks. Of their total lodgments, four-fifths were in the hands 
of five leading banks. 

" " The small private banks, judging by my limited experience, are 
multiplying at a great rate. In every city there is a string of big stores, 
furniture concerns, etc., which do a considerable banking business, as 
an adjunct of their regular business, by taking money on deposit at a 
very high rate of interest and making use of it in their business in the 
way of advance, etc." — Dr. Schmidt, German Bank ' Enquiry, 1908-9, 
p. 249. 

*2 These figures have been obtained in the manner described below. 
Lodgments. — The Economist's totals of the deposits held by the Bank of 
England, the joint-stock and the private banks (mainly as on 31 December 
1 91 3) amount to ,^908 m. This aggregate may be roughly corrected (i) for 


abnormal expansion at the end of the year ; (2) for duplication between the 
Bank of England and other banks ; and (3) for duplication among these 
other banks. 

(i) The following figures show roughly the expansion occurring during the 
last few weeks of the year : — Joint-stock and private banks : Deposits, ^^24 m. ,* 
Cash in hand and at bankers and Cash at short notice, £16 m. and ;^i2 m. 
respectively, or ^^28 m. in all. Bank of England : Other Deposits, £2^ m. ; 
Other Securities, £2.$ m. It seems safe, therefore, to reduce each of these four 
totals by £2-^ m. to correct for the exceptional conditions at the end of the 

(2) Mr. Withers {The Meaning of Money, p. 253) assumes that of the ^51 m. 
of Other Deposits on i Jul> 1908, ^20 m. were held by customers other 
than banks. Taking Other Deposits on 31 December 1913 at ;£6i m. - 
;^23 m. = ;^38 m., and assuming that bankers* balances (in 1908 supposed to 
average ;;^22 m. to ;^23 m.) include £^ m. to £^ m. of aeposits held by Scotch, 
Irish, and other not-included banks, we may perhaps deduct ;^i8 m. from 
Other Deposits and Other Securities to eliminate duplication between the Bank 
of England and the other banks of the system. 

(3) Using as a guide the aggregate Cash and Short Notice money of such 
banks as keep accounts with the joint-stock banks, we may roughly correct 
for this duplication by deducting £$ m. from Deposits and from Cash in hand 
and at bankers. 

This leaves a final figure of ^908 m. - (;^23 m.-f;^23 m.-\-£i2> m.H-;^5'm.), 
say £B>/\o m., which may be separated into lodgments on current and deposit 
accounts on the basis of a few banks which show these items separately in the 
balance sheets. 

Notes. — As 70-75 per cent of the active note circulation was supposed in 
pre-war days to be held by the joint-stock banks (vide Industry and Finance, 
British Association, p. 207), the total of notes held by the public may be taken 
to be £g m. 

Gold, Silver and Bronze. — ^Mr. Eraser (see Economist, 22 August 191 4 
and subsequent controversy) estimated that the total gold holdings of U.K. 
banks in June 1913 were something over ;^ioo m. Adding £^ m. for growth 
and £8 m. for silver and bronze (see Annual Report of Mint), and deducting 
3^10 m. for the probable holdings of Scotch and Irish banks, we get a total 
of ;^i04 m. In view of the criticism of Mr, Eraser's figures, we may take the 
round figure of ;^ioo m. as an aproximate total of the precious metals held 
by the English banking system at the end of 191 3. 

Cash at Call and Short Notice. — This figure may be fairly closely estimated 
from the Economist's summary. The estimate, ;£iii m., must be reduced by 
5^7 m. to correct for expansion at the end of the year. (See under " Lodg- 
ments " above.) 

Investments. — Included in this total is the figure for Other Securities 
reduced by £2-^ m. (See under " Lodgments," above.) 

Uncleared Cheques. — This figure is based on the consideration that sub- 
stantially the whole of one day's average Country and Metropolitan Clearing, 
as well as a small fraction of one day's Town Clearing, is in the post each night 
and so carried as part of " Cash in hand and at bankers." 

The statement based on these figures may perhaps be taken as broadly 
representative of the position of the English banking system as a whole at 
the end of 191 3. It should not, however, be used for any but the most general 
purposes, of the kind for which it is employed in this book ; in particular 
the relation between reserves and deposits which it indicates should not be 
used without taking account, first, of the conjectural nature of the estimate 

NOTES 289 

of the central gold stock and, secondly, of the effect on the volume of deposits 
of different methods of making loans. (See p. 1 36.) 

The following table is a compressed statement of the aggregate figures 
of the five large joint-stock banks, as at 31 Dec. 1921. Their total lodg- 
ments, twelve months earUer, formed 85 per cent of those of all joint-stock 
and private banks (excluding the Bank of England) in England and 

Capital, Reserves and Undivided Cash in hand and at B. of E. 256 

Profits . . . . . . . . 107 Cash at Call and Short Notice 108 

Lodgments . . . . . . 1628 Investments . . . . . . 304 

Discounts and Advances . . 1049 

Buildings, etc. . . . . 18 

1735 1735 

*• The return was confidential. The amount owed by the Stock Exchanges 
to banks, financial institutions, etc., at the date of the return was apparently : — 
London, £S>i m. ; Country, ;^ii m. See art. by E. Sykes in Journal of Institute 
of Bankers, 1915. 

** Sir Charles Addis, writing in July 1918, estimated that in the floating loan 
market there were about ;^300 m. bills under discount, and about ;£ioo m. 
lodged by bill brokers with the banks as security against loans. Art. in 
Edinburgh Review, July 191 8. 

*• These are estimates made by G. Roulleau in Les Riglements par effets 
de commerce. The total grows more slowly in the U.K. than in France or 

*• Art. " Problems of British Banking," The Edinburgh Review, July 191 8. 

*' Misc. Arts, on German Banking, U.S.A. Nat. Mon. Commission, Doct. No. 
508, pp. 159 and 160. 

*8 G. Roulleau, Les Riglements par effets de commerce. 

*• Hartley Withers, The Meaning of Money, p. 205. 

•® For example : "In periods of active trade we know that bank loans 
increase and prices rise." — Mr. McKenna, Chairman of the L.J.C. & M. 
Bank, The Times, 30 January 1920. Again : " One of the reasons why 
there is a great increase in the number of bills at the height of a boom is the 
acceleration of production — so that three bills may be drawn for goods moving 
through successive processes where one was drawn in the same time before." 
— Riesser, op. cit., p. 282. 

" Industry and Trade, p. 631. 

•2 E. T. Powell, The Mechanism of the City, p. 133. 

8' A. Neymarck, Finances Contemporaines, VII. 

•* E. Th6ry, La Fortune puhlique de la France, 191 1. 

*" Journal of Royal Statistical Society, January 1911. 

This estimate takes no account of the amount of private capital (possibly 
^300 m.) invested in the purchase of land, in trade undertakings, bank de- 
posits, etc. To find our net foreign investments in 191 9 it would be necessary 
to add new investments 1908-14 (cf. p. 276), and to deduct (i) perhaps 
^1000 m. for foreign securities sold during the war period (cf. Keynes, Econ. 
Consequences of the Peace, p. 258) ; and (2) the difference between war loans 
due to and from this country (loans to AUies reckoned at one-half their face 
value), say, ;£3oo m. But the bases of these estimates are too rough to justify 
the quotation of any definite final figure. 

»• It is well known that prior to the war a large part of the industries of 
North Italy were controlled by German banks. It was stated authoritatively 



before a recent Board of Trade committee that these banks had financed the 
electrical industry in that area to the extent of I^l^ m. and that the whole of 
that business was in their hands. The German practice in such cases seems 
to have been to undertake the initial financial work requisite for development ; 
to recover their capital by the sale of securities to the public ; but to retain 
control mainly by representation on boards of management and by the use 
of their customers' voting proxies. Another instance is that of the Anglo- 
Argentine Tramways, which were gradually absorbed by a company, nomi- 
nally Belgian, really German. The present Anglo-Argentine Co., it is stated, 
has an English Board of Directors ; but is absolutely controlled by a Belgian 
group which is itself controlled in Germany, all constructional work going to 
that country. 

One banking house in Wall Street controls, or is directly influential in 
the management of, over one-fourth of the railroad mileage of the U.S. ; 
practically controls one, and is represented on the Boards of Directors of the 
other two, of the three largest banks ; is identified with three trust companies 
and one of the four leading insurance companies ; is the chief directing force 
in the coal and iron trade ; has close alliances with leading corporations in 
copper, electric light and telegraphs ; while the par value of the securities of 
the various companies with which it is identified is upward of ;^iooo m. — 
Pratt, The Work of Wall Street, 1903, p. 239. 

" Estimate by A. Neymarck of the valeurs mohilUres actually owned by 
the various countries of the world in 1908. Finances Contemporaines, VII., 
p. 446. 

'^^ " The wholesale grocery business of this country is centred in London. 
. . . Sales are held periodically at the Commercial Sale- Rooms of such im- 
ported commodities as sugar, coffee, cocoa, tea, spices, etc. These are public 
wholesale auctions, open to every one, but in reality only representatives of 
the wholesale houses, and recognized brokers and agents take part in them." 
— W. Abbott, Commercial Theory and Practice, 1917, p. 252. 

5" T. Schilling, London als Anleihemarkt der Englischen Kolonien. 

•° Riesser, op. cit., p. 354. 

«i Misc. Arts, on German Banking, U.S.A. Nat. Mon. Commission, 1910, 
p. 151. 

•2 " It has been estimated that the amount now secured on the debentures 
and debenture stock of trading companies is not less than j^soo m." — E. 
Manson, Debentures of Trading Companies, 1909, p. i. 

«* App. to Report of the Company Law Amendment Committee, 1906 [Cd. 

3053], P- 93. 

"* As a form of organization the private joint- stock company has several 
notable advantages over the partnership or singly- owned business. 

1. The liability of the shareholders is limited, and certain other risks are 

reduced by the transfer of powers from partners to directors. 

2. It has continuity of existence. When a member of the partnership 

dies, his executors incur legal risks if they postpone settlement and 
may incur business loss if they hasten realization of the property. 
With the private joint- stock form of organization such difficulties 
do not arise. Its existence is not affected by the death of a share- 
holder. Admission and retirement is a simple matter ; and the 
sale, mortgage and settlement of parts of the property are greatly 

3. It has special facilities for borrowing, owing to its ability to issue 

debentures and to charge its assets in a manner not open to a 
private business firm. 

NOTES 291 

The public joint- stock form of organization also carries with it these 

Further, its ability to sell its shares to the public widens the market for 
the sale of private undertakings and increases the power of the company to 
obtain the capital it needs for its development. But, inasmuch as its directors 
usually hold only a small proportion of its shares, it suffers much more than 
the private company from the weakness in the connexion between the 
shareholders and the directorate. See, in particular. Palmer's Company 
Law, 1916. 

" " The Daily Money Article," Journal of the Institute of Bankers, 1914. 

Another sUghtly different method is suggested by Mr. Powell. He points 
out that a financial house or a powerful investment trust will take up stock 
in, e.g., a gold mine, whose shares, for want of any immediate yield, cannot 
be publicly marketed. They take shares to provide the necessary working 
capital, getting perhaps a call on the remaining shares at an agreed price, and 
later sell them to the pubhc. — E. T. Powell, The Mechanism of the City, ch. i. ^ 

It is of some importance to notice that the Committee of the London Stock 
Exchange have recently resolved that, before granting leave to deal in 
securities which are issued without any prospectus publicly advertised in 
this country or circular [? circulated] to shareholders, they will require pubUca- 
tion of all the necessary details with regard to the formation and issue of the 
company. The Times, 3 December 1919. 

••House of Commons return re Gas Undertakings, 191 5 ; re Tramways, 

•' The Economist' s figures are drawn from a wide field. A more limited 
source of the information hes in the individual issues published in The Times. 
These individual issues may be separated with tolerable accuracy into appUca- 
tions for capital destined for home and foreign employment respectively, the 
line of division actually adopted passing between investment trusts mainly 
concerned with foreign securities, which are placed in the latter class, and 
Enghsh shipping lines, which are placed in the former class, i.e. their capital 
is reckoned as employed at home. Omitting British Government and rail- 
way securities, short-term bills and municipal borrowings for unspecified 
purposes, the average annual apphcations (191 2-1 4) for capital destined 
mainly for home employment was found to be approximately £'zi\Ta., of which 
some £^ m. was in the form of debentures. 

•* Writing of the " increase of ^^230,000,000 in home capital, computed 
in the Census of Production (Final Report, pp. 32-3) as taking place in 1907," 
Prof. Bowley states : " There is some evidence that this is over-estimated, 
and perhaps ;^2oo,ooo,ooo may be nearer the fact. . . ." — The Division of 
the Product of Industry, p. 20, note 2. 

"• Even during the recent financial boom in cotton securities, these con- 
ditions do not seem to have changed fundamentally. A broker in close touch 
with these developments writes (Nov. 1919) : " In general no prospectus is 
issued. The modus operandi is for an agent on behalf of a syndicate to pur- 
chase the shares of a cotton spinning company by ofiering the shareholders 
a tempting price for their holdings ; for instance, if the shares in the market 
were worth l^, the syndicate offers £1$ or ;£2o per share, provided all are sold. 
The old company is then liquidated, and a fresh one started, with a capital 
in accordance with the amount of the price paid for the old shares, and these 
new shares are taken by local people who understand the cotton business." 

A word may be added with regard to the practice of spinning companies, 
especially in the Oldham district, of borrowing sums on deposit in the manner 


of a joint- stock bank. Such loans may be invited by advertisement before 
the mill is built. In the typical case, deposits would be made of l^ and 
upward ; and amounts of ;^ioo would be withdrawable on demand, amounts of 
3^500 or so at fourteen days' notice. Depositors have for their security only the 
figures in their loan books and their faith in the directors ; they are attracted 
by the simplicity of the arrangement and by a rate of interest higher than 
that paid by the banks. Prior to the war this simple method of obtaining 
capital was of considerable importance in the finance of the trade, the volume 
of loans, in some cases, being greater than the paid-up capital of the borrowing 
company. It would seem that only in very exceptional cases did any loss 
fall upon lenders ; but the heavy proportion of loans to capital was a cause 
of some apprehension in the trade, and even gave rise to suggestions that the 
matter shoula be dealt with by legislative action. 

This method of finance is not peculiar to cotton spinning, but it has gone 
much farther there than in other trades or industries. It may be noticed 
that, according to an official return made in 1905, some 150 boroughs in 
England and Wales had at that date similar borrowings amounting to nearly 
£2, m. In the typical case, the borough used the security of the local rates 
to borrow small sums from several hundred people, the conditions of repay- 
ment ranging from six months' notice to contracts for periods of fifty or 
sixty years. 

'*> Misc. Arts, on German Banking, p. 154. 

'1 Riesser, op. cit., p. 478. 

'2 " During the second epoch [i 870- ] credit banks, in order to avoid direct 
participation, have to a large extent resorted to the intervention of trust 
and finance companies for the purpose of exercising their promoting activity 
and for the financing of subsidiary banks." — Riesser, op. cit., p. 345. 

" U.S.A. Nat. Mon. Commission, Doc. 405, Interviews oh Banking Systems, 
p. 223. Cf. latter part of Note 5. 

'* Art. in Economic Journal, Dec. 1917- (For a sketch of the development 
of these houses, see Mr. E. T. Powell's art. on " The Economic Function of the 
Finance Houses," The Financial Review of Reviews, Dec. 1919.) 

'5 Ibid. Mr. A. S. Dewing in Corporate Promotions and Re-organizations 
estimates that the following figures represent fairly the capitalization of an 
average consolidation in the United States : — 

Actual value of plant 4 million dollars. 

Excess price paid . . . . . . . . . . 2 

Compensation to promoter . . . . . . i 

Compensation to banker . . . . . . . . i 

Bonus of securities to public . . . . . . i^ 

Organization expenses . . . . . . . . ^ 

10 million dollars. 

" ". . . modem company promoting is undertaken by the vendor." — 
Debate on second reading of the Companies Bill, 1900, Hansard, vol. 84, 
1900. Mr. Lawson Walton, confirmed by Mr. Martin. 

" Ibid. Mr. Holland. 

'8 Interviews on Banking Systems, p. 394. 

'» These statements on foreign compsmy law are taken from W. J. Green- 
wood's Foreign Stock Exchange Practice and Company Laws, 191 1. 

80 Art. in Economic Journal, Dec. 191 7. 

81 See debate on second reading of Companies Bill, 1900. 
*2 Art. " Boom Prospectuses," 1910. 

NOTES 293 

" Cd, 3032, p. 10. 

** Palmer's Company Law, loth ed., 1916, chap. i. 

•* H. Lowenfeld, All about Investment, p. 175. 

" I do not know whether the Attorney- General is aware of the nature of 
the amounts now paid by the promoter of a company. Take, for instance, 
the soUcitor. The solicitor very often gets ;£iooo for putting his name on a 
prospectus. . . . This appUes also to the brokers on the Stock Exchange. 
They very often receive ;^iooo for putting their names on a prospectus. ..." 
— Debate on second reading of the Companies Bill, 1900. Mr. Labouchere. 

"• Board of Trade Annual Reports on Companies. 

•' The Mechanism of the City. 

" Cf. in particular, art. on " The Provincial Stock Exchanges," Economist, 

*• All about Investment. 

Mr. Lowenfeld is no doubt using the term " free market " in a narrow sense. 
There axe very large numbers of stocks for which a price both ways will not 
usually be quoted, but which an investor can nevertheless buy or sell on the 
market at a reasonable margin of price. 

" These [smaller companies] often have to issue their ordinary shares in 
the first instance in their own neighbourhood. . . . The dealing in, or the issue 
of, these securities, which are often perfectly substantial, is often almost, if 
not quite, impracticable." — R. H. I. Palgrave, art. in Quarterly Review, Jan. 

"" In a memorandum of Jan. 1920 (Cmd. 594) the Board of Inland Revenue 
draw attention to the influence on market quotations of the " common practice 
in industry (from motives of prudence) to create reserves which are not dis- 
closed in published balance sheets. . . ." They point out (a) that in conse- 
quence of this the market has not always full knowledge of the assets of a 
business ; and {b) that the investor would usually value the shares of a 
company more highly if its policy were to distribute, say, one quarter of its 
profits in dividends, canning the remainder to reserve, than if its policy were 
to distribute a larger proportion of its profits to its shareholders. In a 
number of cases which they investigated, market quotations indicated a 
capital substantially below the true value of the business, i.e. were below 
investment values. 

•1 It is of some importance to bear in mind " the huge difference," as a 
member of the Stock Exchange expresses it, " between effective jobbers in 
a market who have the capital and brains to ... ' run a book,' and the 
m5rriad parasitic jobbers who deal from hand to hand in their wake, rarely 
• . . bu3dng or selling from the pubUc without knowing where instantly to 
undo the business." 

'2 During the war, time dealings have been abolished. At the end of 
1920 they have not yet been reintroduced. 

•* Most of these particulars are taken from Glapham's Woollen and Worsted 

•* Abbott, Commerical Theory and Practice, pp. 246, 247. 

In one large London merchant house the average length of credit granted 
was 3-15 months. (Information given by a London Accountant, 1912.) 
Another large merchant house in Cheapside states that practically all their 
goods are sold on credit and that the average period of credit is about four 
months. Another similar firm says that their cash sales are very small, and 
that three months is the probable average period of credit, 

•* Cd. 9238. p. 12. 

•• Cd. 9092, p. 22. 


•' Cd. 9073. P^ 17- 

»8 Abbott, op. cit., p. 257 and p. 119. 

•» L. D. H. Weld, art. " Marketing Functions and Mercantile Organiza- 
tion," The American Economic Review, 191 7. 

*»°Art. "The Recruiting of the Employing Classes from the Ranks of 
Wage- Earners in the Cotton Industry," Statistical Journal, Feb. 1912. 

1"* Information given by prominent business men in the industry. 

"2 Cd. 9073, p. 32. 

1°^ Information given by such bodies as Chambers of Trade. D Marshall, 
referring to the practice of selling goods on credit, writes : " This tendency 
undoubtedly often makes for an undue extension of the number of traders, 
and especially of retailers ; and there is probably some ground for the sug- 
gestion that there are more traders in many countries than are needed for the 
work." — Industry and Trade, II. vi. 4. 

"* Cd. 9079, App. VIII. 

105 " It is a most valuable asset to the retailer to have a repittation for 
prompt payment. He often receives special terms and discounts, and 
frequently has opportunities afforded of acquiring good lines of goods which 
are denied to his colleagues who are less punctual in meeting their obligations." 
— Abbott, op. cit., p. 128. 

106 Principles of Political Economy, iii. 12, § 5. 

1°' Prior to the war it was apparently a common practice for leather mer- 
chants to give five or six months' credit, generally in form of bills. Pro- 
ducers of leather and shoes have since then greatly increased their financial 
stability, and the system of trade credit has " vastly improved." 2^ per cent 
discount for payment in thirty days (rarely longer) are now the general 
terms. Art. Boot and Shoe Trade Journal, March 1918. 

i*'* Industry and Trade, p. 786. 

1®* Les Reglements par effets de commerce. 

110 Principles of Economics, 5th ed., iv, 12, § 12. 

*ii Census of Production, 1907, Final report. 

"2 c. K. Hobson, The Export of Capital. 

113 Statistical Journal, Feb. 191 2. 

1" See Bowley's The Division of the Product of Industry, f.n. p. 20. 

"5 Information given by prominent business men in the industry. 

11 • Woollen and Worsted Industries. 

11' The result of inquiry made among business men by Mr. K. Broadley. 

118 Industrial Gloucestershire, 1904. 


Abbott, W., on credit buying, 264 ; 

on elimination of wholesaler, 266 
Addis, Sir C, on bank competition, 

149 ; on bill market. Note 44 

Bank Act, 1844, ^26, 165 

Bank of England, as central bank, 
157-60 ; rate policy of, 56-9, 62, 
I 61-4, 169-70 

Bank notes, in U.K., 38, Germany, 
41, France, 42 ; control of issues 
of, 165-6 

Bank reserves, influences determin- 
ing size of, 135-8 ; real costs of, 

137-9. 142, 143 

Banks (U.K.), central, 128, 157-60 ; 
competition among, 149 ; con- 
centration of, 127, Note 40 ; con- 
trol of currency by, 49, 150-3, 
156-60 ; control over industry by. 
Note 56 ; distribution of resources 
by. Chapter XXI, 31, 181 ; 
policy in business cycles of, 56, 
171-6, 180-1 ; profits of, 145, 149 

Bargaining knowledge, in Produce 
markets, 190; in Securities mar- 
kets, 190-1, 193-4, 207-8, 214-5 ; 
of jobbers and speculators. 

Bill brokers, services of, 142 

Bills of Exchange, 40, 48, 106, 
Note 14, Note 44 ; in the U.K., 
France and Germany, 143-4 

Book debts. See Trade Credit 

Boot and Shoe trade, 266, 268, 270, 
Note 107 

Bowley, Prof., Note 68 

Brae, H. H., 252 

Branch bank system, 113, 144-5 

B.S.T. Ltd.. 209 

British Trade Corporation, 212 

Broker. See Bill brokers. Stock 

Building societies, 280 

Business abihty, its junction with 
capital, 3-4, 103-4, 187, 275 

Business cycles, 20, 47-8, 52-6, 71-2, 
1 71-6, 180, 181-2, 271-2 

Capital, Command over, 12 ; com- 
posite supply price of, 72, loi ; 
export of, 69, 186, 205-6, 276, 

Note 55 ; free, 11 ; period of 

supply of, 92-7 ; social demand 

for, 88, 102-3 
Chapman, Prof., 267 
Cheque currency, cost of, 139, 147-9 ; 

efficiency of, 38 ; influence on 

transport of capital of, 144-5 ; 

method of issue of, 129, 131, 150-1 ; 

use in U.K. of, 39, in U.S.A., 41, 

in Germany, 41, Note 12, in 

France, 42, Note 14 
Clapham, Dr., 278, Note 39, Note 93 
Company law, 214-6 
Company promoter, 58, 80, 122, 208, 

213-4, 215, 217-8 
Cotton industry, 203, 208, 267-8, 

278, Note 69 
Cox, A. L., on mortgages, 115-6 
Credit, definition of, 15, Note i ; 

disturbing influence of, 20, 40-1, 

55-6, 168 ; functions of, 16, 17, 

19 ; personal, 105-6 
Credit Foncier, 105, 108, Note 27 
Currency, definition of, 15 ; of U.K., 

37-9* of France, 42, Note 13, 

Note 14, of Germany, 41, Note 

10, Note 12 

Debentures, 80, 107 ; volume of, 

201, Note 67 
Demand, for money and capital 

distinguished, 159 
Discount, Houses, 142 ; market rate 

of. 56-9. 64, 95-6, 162-4, 168 
Done, J. J., on mortgages, 116 
Duguid, C, 203 

Economist, The, 194, 204, 205 
Engineering trades, 266, 279 

Federal Reserve system, 166 
Fisher, Prof. Irving, 55, 174 
Foxwell, Prof., 212, 213, 216, 283 
France, bills of exchange in, 144, 
Note 14 ; cheques in, 42, Note 14 ; 
company law in, 214-6 ; credit 
in, 18 ; currency in, 42, Note 13 ; 
mortgages in, 105, 108, 115, 
Note 27 ; number of banks in, 
127 ; seasonal demand for money 
in, 169 ; securities market in, 
105, 109, 183, 185, 211, Note 5 




Gas and Tramway undertakings, 205 

Germany, bills of exchange in, 144 ; 
cheques in, 41, Note 12 ; company 
law in, 214-6 ; credit in, 18 ; 
credit banks in, 109-10, 125-6, 183, 
197-8, 209-11, Note 56, Note 72 ; 
currency in, 41, Note 10 ; giro 
system in, 41, Note 12 ; mort- 
gages in, 115, 117-8, 126, 169; 
note issue in, 166 ; number of 
banks in, 127, Note 41 ; People's 
banks in, 106, 126 ; seasonal 
demand for money in, 169 ; 
securities market in, 105, 109-10, 
183, 197-8, 209-11, 213, Note 72 

Giffen, Sir Robert, 120, 277, Note 8 

Giro system, 41-2, Note 12 

Gold, in money use in world, 47, 
in U.K., 37, Note 3, in France, 
42, Note 13, in Germany, 41, 
Note 10 

Goschen, 71 

Greenwood, W. J., Note 79 

Hobson, C. K., 69, 276 

Insecurity, 92-6, 113 

Investment, Chapter XI ; foreign, 
69, 186, 205-6, 276, Note 55 ; 
French, Note 5 ; home, 66-72, 
204-6, 277-81 ; influence on 
money supply of, 70-1 ; of banks, 
31, 128, 142 ; risky and safe, 87-9 ; 
individual and social, 68 

Iron and Steel Industries, 279 

Issue Houses, 80, 122, 183, 195-6, 
198, 212 

Issue of notes, and of cheque currency, 
39, 147-8 ; regulation of, 165-6 

Jevons, 14, 55 

Jobbers, Chapters XXXIX, XL, 
223, 236 ; costs of, 241-2 ; 
function of, 236, 240-1 ; import- 
ance of strong, 230, Note 91 ; 
and new issues, 197 ; profit of, 
244 ; " turn " of, 80, 241 

Joint-stock companies, advantages 
of, 187, Note 64 ; capital supphed 
to, 204-5 ; fraud in, 217-8 ; 
influence on demand for capital 
of, 107 ; law re, 214-6 ; losses 
of, 217 ; numbers of, 201-2 ; 
public and private, 201-2, Note 
64 ; use of, in various industries, 

Law, German industrial, of 1884, 
210 ; influence of, on demand for 
capital, 107-8 ; re company for- 
mation, 214-8 

Linen industry, 278 

Loan rates, inequality in, 145 ; to 
Stock Exchange, 142 

Loans, and overdrafts contrasted, 
136 ; to Stock Exchanges, 142, 231 
Lotteries, 89 
Lowenfeld, H., 219, 221 

Market rate. See Discount 

Marshall, Dr., 27, 33, 55, 152, 176, 
275, 283 

Mill, J. S., 270, Note 39 

Money, as part of the system of 
communications, 2-3 ; definition 
of, 15 ; essential properties of, 
34-5, 60 ; imperfect homogeneity 
of, 44-5 ; peculiarities of, 9, 10, 
22-3, 27 ; seasonal demand for, 
169-70 ; services of, 8, 29, 30 ; 
sources of expansion of, 48, 50, 64 

Mortgage banks, 105, 108, 117-8, 126 

Mortgages, 95, 105, 108, 11 5-7, 119, 
126 ; in France and Germany, 115 

Municipalities, loans to, 116, Note 
69 ; sale of securities by, 184, 228 

Negotiable securities. See Stock 
Exchange Securities 

Neymarck, A., on French invest- 
ments. Note 5 ; on world issues of 
securities, 185 

Note issues, and issues of cheque 
currency compared, 39, 147-8 ; 
regulation of, 165-6 

Organic influence of market, 1-5, 
187, 274-5 

Paish, Sir G., on foreign investment, 

186, 276 
Palmer, Sir F. B., on company for- 
mation, 217 
People's banks, 106, 126 
Period of supply of capital, 92-7 
Pigou, Prof., 87, 283, Note 26 
Powell, E. T., 118, 120, 220 
Provincial markets for securities, 203^ 

208-9, 220-2, Note 69, Note 89 
" Purge," The, 108 

Retailers, 266 ; excessive numbers 
of, 114, Note 103; and trade 
credit, 106, 114-5, 264, 267-9 

Risk (Chapters XIII-XV), nature of, 
85-9 ; reduction by market of, 
30, 80-1, 83, 104-8, 122-3, 224-5, 
Chapters XXXII-XXXIII, Chap- 

Room and Power companies, 267, 278 

RouUeau, G., Note 45 

Sauerbeck, Dr., 46 
Saving. See Investment 
Schilling, Dr., 196, 197 
Security, function of, 104-5 ; crea- 
tion of, 107-8 
Shipbuilding, 116-7, 3O5-6, 279 



Silver, in money use in U.K., 38, 
in France, 42, Note 13, in Ger- 
many, 41, Note 10 

Smith, Adam, 89 

Social demand for capital, 88, 102-3 

Solicitors, market formed by, 1 1 7-8 

Speculation (Chapters XXXVII- 
XLII), definition of, 235 ; on Pro- 
duce Exchanges, 236, 238, 241 

" Stags," 198, 233 

Stamp, Dr., 217 

Standard of value, 10, 34, 55 

Stock brokers, services re new securi- 
ties of, 184, 196-7, 209, 214 ; 
services re old securities of, 221, 
223, 240, 243, 245 

Stock Exchange securities, Annual 
issues of, world, 185, London, 
194 ; costs of issue of, 197-9, 
218-9, Note 75, Note 85 ; market 
for, in Germany, 105, 109, 197-8, 
209-11, in France, 109, Note 5, 
Note 27 ; Provincial markets for, 
203, 208-9, 220-2, Note 69, Note 
89 ; social influence of, 186-8, 231, 
Note 56 ; two markets distin- 
guished, 122-3 ; volume of home 
industrial, 201-4, 277-80 

Trade credit, and volume of purchas- 
ing power, 39-40, 269-73 ; and 
transport of capital, 114-5, 263-9 

Treasury notes, 50, 59, 63 

Trust and Finance companies, and 
foreign investment, 71 ; and the 

investor, 80 ; as Issue Houses, 
183-4, 190. 212 ; B.S.T. Ltd., 209 ; 
work of, 1 1 8-2 1 

Uncertainty, Chapter XIV 

Underwriting, 184, 196, 209, 215, 
233, Note 28 ; rates of, 197, 198, 

U.S.A., corporate promotions in, 
Note 75 ; Federal Reserve Board, 
166 ; New York Stock Exchange, 
223, 252 ; number of banks in, 
136 ; trade credit in, 267 ; use of 
cheque currency in, 41 ; wheat 
market in, 252 

Valeurs mobili&"es. See under 
Stock Exchange Securities 

Valuation of assets of joint-stock 
companies, 215-6 

Waiting, Chapters XI, XII, definition 
of. 73. 97 ; influence of market 
on, 80, 94, 123-4, ^34. 224-5, 281 

War, influence of, 49, 50, 62-4 

Wholesalers, as agents for supply of 
capital, 1 14-5, 267-8, Note 94; 
decline of, 266 ; influence on supply 
of purchasing power of, 48, 172-3, 

Withers, H., 169, 171, 246 

Woollen and Worsted Industry, 
263-4, 278-9, Note 39 

Work of management, 80, 119, 120, 
123, 226, 275 





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